Three Thoughts from London – Oil, Art and Credit

International Currency Notes

Ilan Solot discusses three key events: the US department of energy releasing it’s weekly report on inventories; the Hungarian central bank’s message on rates; and the outlook for a ratings downgrade for Brazil.

1) The US department of energy (DOE) releases its weekly report on inventories later today and is expected to fall for the third consecutive week. The last report, out on the 15th, saw a -4346K draw in inventories, the third largest so far this year, against expectations for a decline of only -1250K, so a miss of about 3100K. Despite the bullish data, crude futures fell 3% on that day, driven by news of a deal with Iran. With this now largely priced in, but commodities still very much in focus, today’s data could prove a market moving event, especially if there is yet another large draw in reserves. Expectations are for -1450K today. But here are a few words of caution in interpreting today’s data: (1) the average miss of the inventory data vs. the Bloomberg forecast has been ±3160K over the last 12 months, so last week’s surprise wasn’t that much out of context – although the actual size of the draw was large; (2) whatever happens, inventories will still be very large. As the EIA put it in its last few summaries of the weekly DOE report, “U.S. crude oil inventories remain near levels not seen for this time of year in at least the last 80 years.”

2) The Hungarian central bank was pretty clear in its message to end the easing cycle yesterday: they will hold the target rate at 1.35% “for a very long time.” This came after a small dovish surprise (cutting rates by 15 bp rather than 10 bp). Markets seemed to have welcomed the news, with HUF outperforming yesterday. It’s also worth noting that the MSCI Hungary has massively outperformed, up some 40% YTD vs. -2% for MSCI EM. We are less convinced about further outperformance than many other market participants. The last budget was positive, but now it is already priced in, as is the improvement in the external accounts. On the other hand, Orban’s government has an erratic track record of policy making and is constantly butting heads with the European Commission, so we still see plenty of risks down the line. Either way, at least Hungarian policymakers cannot be accused of being philistine. Last week, the central bank paid $15.8 mln for a 16th century Italian painting as part of a $100 million art purchase program (see image below).

picture3) Just as President Rousseff reportedly agreed to a reduction in Brazil’s primary surplus target (from 1.13% to around 0.15%), investors may have to brace themselves for yet another potential risk: a ratings downgrade that would take the country below investment grade. Moody’s returned from its country visit last week and issued a predictably grim press release, but the rating decision is still to be announced. The agency has Brazil at one notch above investment grade (at Baa2), so a downgrade would be the second by one of the three ratings agencies – S&P downgraded Brazil to BBB- last year. Our proprietary rating model now has Brazil below investment grade. Looking at the corporate side, this has been a difficult year for Brazil (see graphs below using Bloomberg data). Just this year, S&P has taken negative corporate action against 54 companies (vs. 8 positive); Moody’s downgraded 93 companies (vs. 11 upgrades); and Fitch downgraded 86 companies (vs. 6 upgrades). Unsurprisingly, Brazil’s CDS has suffered accordingly (see last graph).

S&P                                                                  Moody’s

S&P chartMoodys chart