This week, Janet Yellen in a speech to Congress repeated herself saying that the US economy was healthy enough for more rate hikes but that the pace would remain gradual. The testimony acknowledged recent weakness in economic data which was dismissed as transitory. Less clear was the outlook for inflation which had also recently weakened despite tight labour markets and falling unemployment. The failure of wages to rise with employment and the persistent lack of inflation is a mystery for everyone including the Fed. Nevertheless, the Fed signalled an impending normalization of its balance sheet, which it would attempt to shrink very gradually by limiting how much of maturing treasuries it would reinvest. It is almost certain that they will not be selling treasuries into the market.

The oil market appears to be forming a base. Oil prices (WTI) hit a year low of 42 just two weeks ago but the market appears to be firming. Certainly the physical market inventories are experiencing consistent drawdowns and demand is consistently strong from healthy global growth. The market had been focusing on the rise of Electric Vehicles, US Shale production and falling costs of production. EV penetration will only be significant some 6-7 years down the road, slowed by regulation and legal infrastructure. Oil supply will likely face constraints well before that and probably remain undersupplied for a good 4-5 years, well before EVs become ubiquitous. US shale may increase production but they do so from a low base of some 5% of global production. Currently they are borderline profitable and appear to be focusing on capacity rather than profitability.

The viability of US shale continuously increasing supply depends on assumptions about costs, and costs can be volatile and are rising. Take for example the cost of fracking sand, which is up from 15-20 USD per tonne in mid 2016 to 40 currently. Frac crews are also in short supply and costs have risen even as rig counts have rebounded. The media has covered the flurry of activity in US shale while non OPEC ex US future capacity is suffering from underinvestment resulting in accelerating depletion and decline rates. One might go as far as to say that Saudi Arabia, far from being the supporter of oil prices, through its communications, is a risk to the oil price, and that, left to its own devices, the market might recover on its own.

And the materials recovery seems to be getting a second wind. Base metals may be volatile but the global synchronized recovery in manufacturing and construction in China and India are supporting prices. In metals, a parallel narrative to the underinvestment in oil is playing out more closely to fundamentals.

US banks reported solid results beating estimates. For all that, bank shares fell as expectations had been built up rather too optimistically. Our interpretation is the following: the major US banks have more than built up capital buffers over the past few years and are now in a position to focus on shareholders’ returns. That regulation is being moderated will only aid the pace and extent of paying out earnings to shareholders. We see this as a durable trend which tilts value towards equities from senior debt.

Week ahead:

Jul 17
• China GDP
• Singapore trade data
• China retail sales
• US Empire State

Jul 18
• Eurozone HICP
• ZEW Survey

Jul 19
• ECB MPC
• US building permits
• Housing starts

Jul 20
• ECB MPC – Draghi speaks
• BoJ MPC – Kuroda speaks
• UK retail sales
• Singapore CPI
• Eurozone consumer sentiment
• Philly Fed

Jul 21
• UK PSNB