February 28, 2020 / 12:14 PM / a month ago

Column: Oil traders price in coronavirus-driven recession

LONDON (Reuters) - Oil traders and other financial investors are anticipating a severe slowdown or recession in the global economy as efforts to contain the coronavirus fail and restrictions on business activity and transportation proliferate.

Pump jacks are seen at the Ashalchinskoye oil field owned by Russia's oil producer Tatneft near Almetyevsk, in the Republic of Tatarstan, Russia, July 27, 2017. REUTERS/Sergei Karpukhin/File Photo

U.S. Treasury notes maturing ten years from now are yielding less than 1.20%, a record low in a time series stretching back to the 1950s, as risk aversion intensifies and investors anticipate interest rate cuts.

Treasury inflation-protected securities (TIPS) with a similar maturity are yielding -0.30%, guaranteeing losses after inflation if they are held to maturity, but at least limiting the scale of the losses, unlike riskier financial instruments.

TIPS yields have fallen more than 50 basis points since November and are at their lowest level since May 2013, when they were still artificially repressed by the Federal Reserve’s quantitative easing programme.

In recent days, U.S. interest rate traders have priced in a 25 basis point cut in the federal funds target rate by the end of April, according to fed funds futures prices, as the central bank responds to deteriorating economic conditions.

U.S. equity valuations have fallen sharply and their positive deviation from the long-term trend has been reduced by around half over the last week.

(Chartbook: tmsnrt.rs/2I5RHiJ)

The U.S. S&P 500 equity index closed on Feb. 27 around 18% above its long-term trend, down from 34% above its long-term trend on Feb. 19.

And front-month Brent futures prices are down almost 24% compared with the same time a year ago, the sharpest year-on-year decline since September 2019 and before that May 2016.

The fall in Brent is consistent with a severe slowdown in global manufacturing activity (such as mid-2019 or in 2015/16) or an outright recession (2008/09 and 2001/02).

At the start of the year, most investors and oil traders were anticipating an acceleration in global economic growth and oil consumption in 2020 after below-trend growth in 2019.

The trade truce between the United States and China, three rounds of U.S. interest rate cuts in late 2019, and a shift to more monetary and fiscal stimulus around the world were all expected to lead to a cyclical upturn.

In the final three months of 2019, hedge funds and other money managers had purchased the equivalent of more than 500 million barrels of futures and options betting on an increase in oil prices.

By the end of 2019, hedge fund positioning in petroleum was the most bullish for more than 15 months as portfolio managers anticipated faster oil consumption growth in 2020.

But the proliferation of business and transportation shutdowns as governments and firms respond to the coronavirus outbreak has forced an abrupt reassessment of the outlook.

Fund managers have sold more than 450 million barrels of petroleum futures and options since the start of the year as the prospects for oil consumption have deteriorated.

The interplay between coronavirus and a global economy already weakened by the trade war in 2018/19 is threatening to push the economy towards a double-dip slowdown or even a recession.

John Kemp is a Reuters market analyst. The views expressed are his own.

Related columns:

- Learning to live with coronavirus in our midst (Reuters, Feb. 26)

- Coronavirus likely to have severe but short-lived economic impact (Reuters, Feb. 20)

- Coronavirus and the impact on oil consumption (Reuters, Feb. 4)

- Priced for perfection, oil slides on fears coronavirus will hit demand (Reuters, Jan. 24)

Editing by Mark Potter

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