Oil price collapse fuels coronavirus economy fears | thearticle

If the angst levels you’ve been experiencing about coronavirus and its impact on the global economy and markets weren’t elevated enough, an overnight collapse in oil prices has just added to

them. We now seem to be in the grip of a vicious deflationary shock that has turned from a risk scenario to a reality in less than three months. Policymakers are under pressure to act as

they did at the end of 2008 as the financial crisis erupted, but mostly cannot. UK Chancellor, Rishi Sunak, will have his chance on Wednesday when he makes his Budget speech. But what are

his global peers dealing with? The oil shock was certainly not on most people’s radar. It’s basically the outcome of a spat between Saudi Arabia and Russia. Because of the economic crunch in

China, now spreading globally, the price of crude had tumbled by a third to about $45 a barrel since the start of the year. The Saudis wanted to enlist the support of Russia and OPEC

members to stabilise the price by restricting production, but Moscow has a different agenda, in which it sees low oil prices as a way of weakening the US shale oil industry. The US, in case

you missed it, is the world’s largest oil producer. Russia refused to support the Saudis, and so the latter decided to boost production to probably 10-11 million barrels a day, and offer

price discounts of up to 20 per cent. In effect, the Saudis are saying to Russia, “You want low oil prices? chew on this!”. Brent crude fell by a third overnight to nearly $30 a barrel,

before rallying to about $35. How these politics play out remains to be seen. For now though, the collapse in prices is bad news for oil-producing nations and energy companies, really bad

for US shale oil producers unless they have already hedged future revenues to protect themselves against falling prices, and an additional blow to global equity markets where oil and gas

companies are significant components in stock market indices. And it doesn’t end there. Most people know VAR as the notorious ‘video assistant referee’ in soccer, but in finance it stands

for ‘value at risk’, and is a measure of risk and volatility in the investment portfolios of asset management firms that look after pensions, savings products, insurance funds and so on.

Markets have been skittish enough over Covid-19, but the abrupt shift in oil prices has lead to a surge in equity market volatility. As volatility rises, managers have to reduce risk, which

has compounded the selling in markets as we have seen today. The FTSE 100 Index, for example, has now fallen about 20 per cent over the last month, with other European indices, the US Dow

Jones and S&P, and Japanese Nikkei markets falling a comparable amount. Bond yields, which move down when bond prices rise and vice versa, have also plummeted. The benchmark US Treasury

bond yield has fallen from nearly 2 per cent since the end of 2019 to under 0.5 per cent. In the UK, gilt yields are virtually zero, and barely 10-15 basis points at 10-year maturities.

These market changes have been extraordinary, and reveal a major concern about recession, a fall in earnings or profits, and the perils of deflation. If there is any good news in this, it is

that we do not face a systemic meltdown such as that which bared its ugly face in 2008. A recession would, of course, expose companies and banks to cashflow and debt service problems, and

we would hope that central banks are alert to the need to ensure that viable banks and companies can access liquidity and other assistance if needs be. Governments could offer easier tax

payment and other facilities to tide firms over what promises to be a difficult six months ahead. Further, low oil prices may be poison for producers, but they are a boon for consumers.

Airlines, for example, that are being savaged by coronavirus-related cancellations or bans, can at least expect a bit of relief from cheaper fuel costs on the routes they continue to fly.

Unless governments use the opportunity of lower oil prices to raise energy taxes, the effect of cheaper fuel will act as stabiliser in its own right, and perhaps in due course a boost to the

economy again. A third factor is that this public health scare will at some point stabilise, and economic life will gradually start to get back to wherever we were before the outbreak

started. Some people’s travel and leisure habits may change permanently, some firms’ supply chain management strategies may change as they reconsider for example, reliance on China, or

whether to bring parts of their operations closer to home. Yet, the demand shock from virus mitigation measures that result in spending and borrowing decisions going into the deep freeze, or

people not going to places of work, will surely wind down before too many months have passed. Normalisation may not be quick, and there may be concerns about what happens to the virus next

winter or before there’s a viable antidote. In 6-12 months, though, we will probably have moved on. Judging by the experiences of China, South Korea, and Italy, though, the worst of the

outbreak may yet be ahead of us in the northern hemisphere. What we didn’t need was an oil price war to — at least initially — exacerbate the underlying deflationary conditions which were

fuelling market angst in the first place. If the global economy is indeed in, or falling into a recession, a 20 per cent fall in equity values from high levels looks, historically, to be not

much more than an hors d’oeuvre. Things could get uglier yet. We should expect policymakers to wheel out a series of measures designed to help stressed firms and households manage balance

sheet problems resulting from cashflow and liquidity shortfalls. We should expect some forms of macroeconomic stimulus, as governments use zero borrowing costs to help support demand — even

though these may have been in the pipeline regardless. We should expect politics to be even more unpredictable than usual. How will Italy, the G7’s weakest member economically and

politically, emerge six months from now? What will coronavirus and its consequences have for the UK’s Brexit thinking and strategy? Will we remain determined to cut and run on December 31,

if there’s no trade agreement with its name?  And how will US voters judge President Trump in a public health crisis which is robbing him of at least the economy and markets feathers of his

MAGA hat?