Forex Education -

Political crisis in Venezuela and US pressure makes up two pillars in bull oil market

Shedding some light on the influence of the US-Venezuela spat towards oil Apart from currency pairs, retail traders exploit the opportunity to speculate other assets. Crude oil is one of the most popular assets. Petroleum is traded through CFDs or a contract for difference. One CFD means buying or selling 100 barrels of crude oil without actual delivery of a commodity. Trading crude oil is available at particular hours. For instance, North Sea Brent Crude is traded from 01:00 am on Sunday GMT+00 until 10:00 pm. The oil market is closed overnight from 11:00 pm until 01:00 am. Oil deals cannot be executed at this interval. Oil CFDs are valid over a particular term. When contracts expire, deals are closed at current market quotes. To profit from trading oil with CFDs, you should grasp the principles of how and why oil prices fluctuate. To begin with, crude oil is the basic commodity for the energy industry. Thus, it is bought by virtually all countries. The bulk of oil production comes from the US. So, oil invoices are settled in US dollars worldwide. Therefore, crude oil and the US dollar are closely linked. If you want to predict a dynamic of oil prices, it would be a good idea to monitor fluctuations of the US currency. Make sure you take notice of all factors which matter a lot to the greenback such as policy meetings of the Federal Reserve, employment data, GDP rates etc. On the contrary, if oil prices develop a rally or lose ground for reasons other than macroeconomic data, this is also mirrored in the dollar's value, thus changing trajectory of many currency pairs. Besides, petroleum is highly sensitive to social and political causes in the world, especially in oil exporting countries. For example, when the US imposed sanctions on Iran due to its nuclear program, the global oil market responded with a rally because of a tighter supply. Regular military clashes in the Middle East also trigger price fluctuations and even sharp price swings.                       In 2019, political jitters in Venezuela have been a major catalyst for twists in global oil prices. Indeed, this OPEC member holds the largest developed oilfields on Earth. In January 2019, the opposition declared their leader Juan Guaido interim Venezuela's president despite the fact that incumbent president Nicolas Maduro had not stepped down yet. Some countries, in particular the US, have already welcomed the new self-proclaimed president. By contrast, Russia and China are backing the legitimate Venezuelan president. The thing in this saga that arouses keen interest among energy investors is how crude oil responds to developments in the upper echelons of power in the Latin American country. ForexLive The US has already slapped various sanctions on Nicolas Maduro and his hardliners, meanwhile avoiding restrictions on the whole oil sector of Venezuela. The situation could change anytime soon. US President Donald Trump warned that he is ready to impose new sanctions on the back of growing clashes over Maduro's autocratic rule. Oil output in Venezuela used to be 3.4 mln barrels per day during the economic boom but it was slashed to less than 1.2 mln barrels in 2018. Venezuela is the third major supplier to the US in terms of oil shipments volumes. Bigger oil exports come from Canada and Saudi Arabia. Nearly half of the current oil output in Venezuela is exported to US oil refineries. One of them, Citgo, is owned by PdVSA, the Venezuelan state-run oil and gas company. Venezuelan heavy acid crude oil has to be mixed with other grades for further processing. If the whole Venezuelan energy sector is subject to sanctions, prices of heavy crude grades will surge instantly. Prices of similar crude grades have already soared by 6.25%.                                         Canada extracts equivalent crude grades from oil sands in the province of Alberta. However, US oil refineries which are mainly located along the coast of the Mexican Gulf will encounter troubles with such oil supplies due to the frail logistics infrastructure throughout Canada. Channeling oil from the Persian Gulf region is also a tricky solution as it takes too much time. In essence, in case the Venezuelan oil sector is targeted by sanctions, US refineries at the Mexican Gulf coast which process the Venezuelan petroleum will have to deal with higher production costs. If they have to reduce their production capacity, this could inflate petrol prices in some regions.               If the US announces fresh sanctions on Venezuelan oil companies, there is a likelihood that the LatAm country will also halt purchases of American petroleum products even if this decision causes more damage to Venezuela than the US. According to the US Energy Information Administration, Venezuela imported over 3 million barrels of refined oil from the US in October 2018. At present, domestic refineries are not able to produce enough petrol and other petroleum products to satisfy local demand. Since 2016, Venezuela has been importing petrochemicals which are blended with heavy domestic grades for further exports. If the trade with the US is terminated completely, Venezuela's oil exports could decline to a large degree until the LatAm country discovers a different source of lowering oil viscosity.                     As a rule, Venezuela's public budget is mainly replenished by revenue from its crude exports to the US. Revenue from other oil exports is allocated for repaying loans borrowed from lenders, including Russia and China. If Venezuela fails to fulfill its commitments to Russia's Rosneft, this oil company will be able to claim the right to PdVSA's stake in the US. In fact, PdVSA's debt to Rosneft is secured by a 49.9% stake in the Citgo oil refinery.                      The US government is likely to ban a Citgo acquisition deal by Rosneft, citing national security. This scenario could spark a standoff among Venezuela, Russia, and the US. If PdVSA defaults on its debt and the US Department of Justice freezes the Citgo's stake for Rosneft, the logical development is that the equities will be sold at a discount to a company agreed by the parties.Obviously, the sanctions will deal a serious blow to Venezuela. Besides, the sanctions will also exert an immediate adverse effect on the US. Nowadays, US storage facilities have been filled up with petroleum products. US refineries are running at full capacity, thus amassing huge stockpiles. Meanwhile, Mexico has halted oil imports from the US as the government launched a crackdown on fuel theft from pipelines. In case Venezuela retaliates against the American sanctions by halting US oil imports, we will see US oil inventories swelling. Most analysts reckon that oil output in Venezuela could contract to 1 mln barrels per day in 2019. The worst-case scenario suggests even bigger production cuts. Experts foresee a surge in oil prices in May. A variety of factors could dwarf supply in the global oil market this spring: sanctions against Venezuela, the beginning of vacation car journeys in the US, expiry of waivers granted to major buyers of Iranian oil, and the ongoing pact on oil production cuts by OPEC and its allies.                To sum it up, with any developments in Venezuela, including the scenario of Nicolas Maduro asserting his power, the US will step up its pressure on the Latin American country which will have to curb its drilling activity and petroleum exports to the global market. There are weighty reasons to expect a rapid rally of oil prices in the first half of 2019. Therefore, crude oil is likely to be a lucrative and above all liquid investment asset that will make an impact on Forex. Importantly, a steady oil rally will be certainly bullish for commodity currencies that will support domestic economies of the countries assigned to emerging markets.  This article was submitted by InstaForex.

What is Goodhart's law

When everyone is looking at something, it changes In quantum physics, the observer effect is the theory that simply  observing a situation or phenomenon necessarily changes that phenomenon. Economics has something similar, called Goodhart's law. It's named after British economist Charles Goodhart who observed that when a measure becomes a target, it ceases to be a good measure. The issue is that once everyone is watching a measure or a target and knows what it means, then the observers anticipate the effects and adjust for the outcome, thus changing the effect. The idea is prescient because of the market's intense focus on the yield curve inversion. When longer-dated yields fall below shorter-dated yields, it's a classic recessionary signal. Intuitively it makes sense because it signals a situation where people would rather have long-term safety than earn more yield in the near-term. Its effectiveness as a predictor of recessions is undoubtedly excellent but whether the curve is inverted is always a matter of interpretation. Surely 10-year yields falling below 3-month bill yields is an inversion but is 5-year yields falling below 2-year yields as strong of a signal? More importantly, does Goodhart's law apply? If all market participants believe it's a sure sign of a recession, then they will surely behave differently than they would otherwise. Similarly, central bankers are also watching the yield curve more closely than ever and as the curve approaches inversion, they may react. Taken to a further extreme, you may have central banker who actively target the entire yield curve in the belief that so long as the curve is steep, a recession can't occur. The idea of Goodhart's law is that any statistical relationship will break down when used for policy purposes. This is frequently seen in regulation and even in the workplace. Whenever targets are set, people find ways to game and abuse them, and so do broad markets and the economy. ForexLive

Here's what a recession really looks like

It's not that bad I posted a part of this chart earlier but here's a longer version. It shows Canadian GDP for the past 50 years. It's similar in most of the world. It's beautiful chart going from the lower left to the upper right with some tiny dips. I feel like the perception of growth is something far different. I don't know if it's the scars of the crisis or the experience of a few outliers like Italy and Spain but the reality is that recessions are bumps in the road. Yes, for some people who lose jobs/careers it's heartbreaking but as investors we see recessions as these mythical dragons to be feared but they're more mosquito than monster.     As investors and traders, recessions are incredible opportunities to find mis-priced markets and if you have a longer view and a steady hand then your path -- like this chart -- will be higher.

How the Bank of England got its nickname

The Old Lady of Threadneedle Street The Bank of England has been at the same location in the hear of the City of London since 1734. The stone complex fills an entire block with its entrance on Threadneedle St. It's nickname came from this 1797 James Gillray cartoon that shows the Prime Minister -- William Pitt the Younger -- trying to get the central bank's gold as part of the protest against paper money. The BOE is not the world's oldest central bank, that title is held by Sweden's Riksbank, which was established in 1668. The Bank of England also holds the world's second-largest gold vault after the New York Fed holding about 400,000 bars worth more than GBP100 billion. The UK central bank has a rich history and Mark Carney is the 121st governor as part of one of the great banking legacies. However, despite the nickname, no woman has ever led the Old Lady. Bloomberg has more on the history and if you're ever in London -- like for the 2018 Finance Magnates London Summit --  the BOE has a free museum that's worth a quick trip.    

China's foreign minister has no idea how the yuan exchange rate is set. Do you?

Yesterday a China foreign ministry spokesman said "The exchange rate of China's RMB is determined by the market. There are ups and downs. It's a two-way float" Wrong. Each day the People's Bank of China set a 'reference rate' and allows the market to trade the rate plus or minus two percent from that rate. So, no, not a free float at all. The end.  - There is a 'pirate' currency that can trade at whatever rate you like, the offshore yuan, CNH.  So there is that. Stay tuned for today's RMB onshore mid rate setting, it hits just after 0115GMT and ForexLive reports it each day. Oh, while we're on the foreign ministry comments, the spokesman also said China is not engaged in a currency war,  China is not trying to boost exports through competitive devaluationChina's economic fundamentals are sound I'll leave it up to you to decide if that is more b/s or not. 

The 'second demographic transition' might be the greatest long-term threat to markets

Where have all the children gone? In the long-term, the answer to every question is demographics. Changing ages and populations determine an enormous portion of which companies and countries will be successful. At the same time, they're one of those things that moves so slowly that we rarely stop to consider them. So the new buzzword/thing that people who talk about demographics are talking about is the 'second demographic transition', which immediately begs the question: What was the first demographic transition? It is the shift from high birth rates to low birth rates as mortality rates fall. It's consistent globally and is marked by the shift away from very large families. It came with a lag in places where mortality rates fall, usually due to improvements in medicine. The first demographic transition was initially thought to be the only demographic transition. The belief was that birth rates would level off around replacement at 2.1 per woman. That hasn't happened. Instead, in most of the richest countries -- particularly the more-secular ones -- rates have fallen below that and in some cases, far below. The United States and UK are at 1.8, Canada is at 1.6. Italy is at 1.4, Denmark at 1.7, Germany at 1.4, Japan at 1.4, South Korea at 1.2 and China at 1.6 as of 2016. The inclination is to believe that lesser-developed countries are still growing rapidly but that's not the case. Brazil is at 1.9 and all of Latam at 2.1, the Middle East and North Africa at 2.8 with the only truly high birth rate in sub-Saharan Africa at 4.8, which is about where the US was in the 1950s. The world is at 2.4 and falling. The average woman is having half as many children as their mother. This is the second demographic transition. You might be tempted to think this is a good thing because since Malthus more than 200 years ago, humanity has been fretting about overpopulation. Like all things in markets: When everyone piles into one side of the trade, it's the other one that wins out. Why is it a problem for markets? I would conservatively estimate that half of corporate profits over the past 50 years have been due to a growing population and the rise of the middle class in emerging markets. All companies ultimately make things for people and if there are fewer people, there will be fewer profits. Debt is a bit more complicated. In theory, the remaining people should be richer per capita than their parents and the excess savings will allow them to be creditors, which would make for a strong market for increasingly indebted countries, especially in an environment of falling stock prices due to lower profits. However, higher per capital wealth isn't a given. Take housing. Even in an environment with a small surplus of housing, prices quickly fall. A house with no one to live in it isn't even worthless -- it's a ongoing cost due to property taxes. So if you bring housing values down to construction costs, that is a massive drag on per capita wealth. What most countries have been relying on is immigration. It's the easiest way to supplement a declining population but I expect the glory days of immigration to the developed world are behind us. Rising wealth and living standards are helping to keep people at home, net migration in India and Brazil in 2017 was flat.  That likely means a future where countries compete for more aggressively immigrants or they lower standards, which could backfire into more pressure to close borders. Even the staunchest pro-immigration policymaker will admit that a doctor from India is more likely to make a positive contribution than someone who can't read.  Another option, and this is already underway, are government incentives to have children. France might be the best example of this. It has a strong social safety net and recognized the problems of a declining birth rate early on and is Europe's most-fertile country. Benefits include long maternity leaves, cash allowances and subsidized daycare and spending in the EU ranges from 2-4% of GDP. These policies have helped but even countries with the most-generous programs aren't particularly close to 2.1. France in 2018 fell to 1.88 in 2017 in a steady slide from 2.0 in 2014. Even more frightening is the cultural change in views about having children -- the way we think about the purpose and meaning of children. Historically, they were critical to replenishing the tribe. They were labour, a way to honour God, and perpetuate the family name -- a necessity. Now they're a lifestyle choice increasingly seen as a sacrifice and a commitment that's growth from 13 years to 18 years to 25 years and beyond.  As for what the future holds , your guess is as good as mine.

The output gap is like a lot of things in economics: It works in theory

Don't mind the gap The Bank of Canada was talking about the output gap way before it was popular. It's been the central bank's guiding light for years. A report the BOC released Friday shows they might be having second thoughts. The output gap is a simple concept. An economy has a speed limit -- an amount it can grow before sparking inflation. The gap is how much below the speed limit the economy is operating. If there is a big gap, like there was after the crisis, then you can stimulate an economy for years before it gathers enough speed to test the limit. It all makes perfect sense. The problem, as the BOC outlines, is that the output "is unobservable and highly uncertain". Essentially, you don't know what the speed limit is. And if productivity improves, the speed limit moves higher. There are all kinds of ways to estimate the output gap but the new study from the BOC suggests they're not very at forecasting when inflation will appear. "We find that most output gap estimates do not appear to add much information to simple models with lags of inflation in forecasting total CPI inflation and CPI-median," the study says. More importantly, they found that using real-time data did little to understand the output gap and what it meant for inflation. Ultimately, this report should once again humble central bankers. In a globalized world it's even more difficult to predict or observe when an economy is running at full capacity. It all begs a different question: Instead of having an inflation target, maybe central banks should have a wage inflation target?

If unconventional tools are used as a substitute for rate hikes, how does FX respond?

How unconventional tightening works Its via HSBC, titled 'FX and yield curve', and the broad 'rules of thumb' are summarised below: The market is increasingly fixated on the prospect of unconventional tightening. In the US the focus is on a reduction of the Fed balance sheet and in Europe there is an expectation of a tapered rate of bond buying by the ECB. In a normal tightening cycle, hikes in policy rates would lead to an increase in short-term interest rates and this has typically led to a stronger currency. The FX market understands this process well. However, if unconventional tools are used as a substitute for rate hikes, how do we deal with this in the FX market? Unconventional policy measures may change the shape of the yield curve as much as they change the level of rates. So to answer this question we need to measure how changes in both the level and shape of the curve influence exchange rates. Rules of thumb We have modelled the relationship between changes in swap rates and FX returns. We note the following rules of thumb: Not surprisingly, higher rates are associated with a stronger currency.Once we have accounted for the change in the overall level of rates, a steepening curve is associated with a weaker currency.When both the level and the slope of the curve change, the change in the overall level of rates is the most important variable. These rules of thumb can help you to translate your views about interest rates into the FX space. Model behaviour In addition to the broad rules of thumb above, two other notable results will be helpful to those of you building formal models: It is not just the interest rate differential which matters. In the FX market it is common simply to compare the FX return to changes in an interest rate differential. However, we find that this approach can miss important information and suggest that it is better to consider rates from both currencies as separate variables, rather than simply the differential.The model parameters change over time. The sensitivity of FX to rates changes over time. This means that model parameters must be frequently updated to prevent them becoming stale. - Some food for weekend thought there

Why FX intervention is far more rare than rumors about intervention

Why central banks rarely intervene in FX From time-to-time I see questions/comments on why central banks don't intervene to push currencies where they want them, instead of just talking about valuations etc. A lesson to draw from Chinese FX reserves is that intervention costs money ... for example, in order to support the yuan (i.e. they are slowing its fall, that's pretty much all) the People's Bank of China is buying CNY and selling USD (or other currencies as the case may be).  As you can see by the level of China's foreign currency reserves, its not as if the PBOC is short of a bit of FX cash to splash if they wish, but that's not the point, intervention does have a price. China can afford it. Not all countries are in the same flush position. Central banks from other countries don't have quite the level of reserves to play with. As an example, the Reserve Bank of New Zealand do intervene from time-to-time, but they have much smaller reserves to play with. The RBNZ has a 'traffic light' system guiding the timing, trying to be effective and get the most bang from their (foreign) buck. I've posted on it before, here (and there are other links at that post to more if you are interested). While this guide is specific to the RBNZ its not too much of a stretch to say other reserve-challenged central banks have a similar approach.

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