Weekly Market Insight

Latest Economic & Market Update 28th April 2020

28th April 2020

Tuesdays Covid-19 Update: The price of WTI fell over 24% yesterday | The Bank of Japan announced fresh stimulus

Latest Economic & Market Update
Good Afternoon, it is 28th April 2020 and here is your economic and market update from BlackBee
Today we are going to focus on:
>A potential re-run of negative prices for West Texas Intermediate.
>Small cap stocks underperforming large cap stocks.
>Lending criteria restricting small businesses from accessing funds in the Main Street Lending Programme.
>Central Banks without accurate inflation data.
>The level of the BOJs involvement in Japans domestic bond market.
After a few days of positive trading sessions, the price of WTI fell over 24% yesterday. On Monday the 20th April, the final day of May’s futures contract, the WTI fell into negative trading territory as suppliers paid buyers to take the barrels of oil off their hands due to a lack of storage capacity. A repeat of this is feared by investors for June’s contract. In a futures contract, whoever is holding the contract on the final day, will realise a physical delivery of the commodity. Despite Saudi Arabia cutting oil production ahead of the scheduled cut, demand is too weak to realise the effect a supply cut will have on the price. The longer the lockdown remains in place, the more significant an affect it will have on the oil industry, evident in the fact that over 60 operating rigs were cut by drillers in the week leading up to April 24th, a result of the severe fall in prices. With demand being so low, the attention is on storage capacity. The ideal scenario for oil producers would be to store and sell at a higher price, however with storage capacities reaching their limits, producers have nowhere to keep the oil, forcing them to sell at significant discounts and, as seen in May, even pay buyers to take the oil off their hands. The fear of a repeat of May’s contract has also influenced the largest oil ETF, USO, to sell 20% of its $3.6bn portfolio, which will be done over a four day period. Markets continue to rise, influenced by the hopes of fresh stimulus and economies reopening. However, as investors buy into the market, they need to be cautious, as this does not mean things will be going back to normal. The full effect on the economy is still yet to unfold and the US and Eurozone GDP reports this week will give further insight into the damage the lockdown has caused. By measure of the Russell Indexes, smaller companies appear to be fairing worse than the large cap companies. The Russell 1000 represents large cap stocks and the Russell 2000 represents small cap stocks. The Russell 2000 has underperformed the Russell 1000 by over 13% during this crisis. Secular growth trends that are seen in the large cap stocks are seen as more of a “Safer Haven” in comparison to the small cap stocks who may be vulnerable to seasonal or cyclical changes in growth.Under the Main Street Lending programme in the US, there are rules that state that in order to access loans, the debt of the business cannot be greater than six times their EBIDTA. This programme is aimed at small and medium size businesses. The criteria could restrict some businesses obtaining loans through the programme, and without access to the available funds, many would struggle to survive the crisis. These loans are also not forgiven, meaning that borrowing rates must also be controlled so the businesses can sustain the debt and not be overwhelmed by the cost of the debt. The restrictions on debt levels will need to be lifted so many of these businesses can access vital funding. Access to the funds could be the deciding factor if these businesses survive the crisis or not.

The inflation rate is vital to Central Bank decision making. It is measured by recording the price change of a basket of goods and services. However with the lockdown in place, a wide array of businesses are closed, restricting the range of consumer spending. This makes it hard to accurately measure inflation. It is posing as a worry, as the effect of current Central Bank stimulus cannot be fully measured. Central banks need to be cautious to not fall into a deflationary trap. When the economy reopens and spending picks up, a clearer picture will form regarding the effect of the stimulus programmes.The Bank of Japan announced fresh stimulus on Monday as they provide fresh liquidity into the bond market. 50% of Japanese government bonds are already owned by the BOJ. This fresh stimulus could see them own half of the outstanding commercial paper and one sixth of outstanding corporate bonds. As the domestic corporate bond market in Japan is still relatively small, the BOJ will be competing with pension funds and life insurers. The move should drive the price up of the bonds up and therefore yields down, keeping borrowing costs low.