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Grappling with the recession

The duration of the extreme measures is still the most crucial question affecting economic prospects and asset valuations.

Red arrows fall to the ground, indicating the economic recession that will occur in 2020.

by
John Redwood

in Features

06.04.2020

Many streets and roads are quiet in the advanced world as the lockdowns reduce travel to a trickle. Most of the major car production plants are shut. Car sales are plunging. Boeing continues with its factory closures whilst much of the world’s fleet of passenger jets are parked with no business. Many factories are also closed. All this means a sharp plunge in the demand for oil products worldwide. The oil price would have fallen anyway, as producers of crude struggled to reduce output or to sell into a market in glut. As the storage tanks fill up so the calls for production cuts get louder.

The Russians, Saudis and the USA have chosen this backdrop to pursue a trade war about who should lose market share at the same time as the market is in freefall. The threat of even more Saudi and Russian production being opened up at a time like this led to a bigger slump in the oil price last week. President Trump’s unlikely intervention as a possible deal maker or peace broker between the big three oil producers temporarily pushed up the oil price. This week there will be attempts to reach decisions on production cuts rather than Saudi Arabia continuing with her strategy of regaining market share at ever-lower prices.

The problem Russia and Saudi Arabia face together is that given the very large reduction in total demand worldwide, just cutting a few million barrels each in the usual OPEC plus Russia way will not be sufficient to turn the oil price around and sustain much higher levels. They also have contradictory objectives, both wishing to cut prices to drive some US shale out of business and then wanting to boost their own revenues.  Mr Trump also has to confront the contradiction in the US position. The USA wants Russia and Saudi to cut back output, but usually argue that in their free market system they cannot instruct US companies to shut down production to help out. In practice, there are likely to be cuts in US output this year as financial reality and the high cash demands of shale have their impact. Maybe Mr Trump could meet his shale industry representatives again and cobble together some language about the likely future pattern of output, but it may not be enough for Saudi and Russia. Saudi is fed up with taking the production cuts to allow US shale to grow. Saudi does, however, always have to consider how far she complains given her dependence on US weapons and military support.

We will watch the diplomatic comings and goings in the new world of virtual conferences carefully, now scheduled for Thursday for OPEC. Were they to announce no deal, the oil price would likely plunge. If they do produce some cuts and some more positive language, the rally will be limited by the underlying reality that the world, for the time being, has far too much oil and is not currently burning much of it. In more normal times the drama between Russia, Saudi Arabia and the USA over oil would be the main focus of market attention. Today it is a sub plot in the tragedy of the bigger demand issues raised by government responses to the epidemic.

This week will see more advanced countries asking themselves how and when they can start to allow a return to work by some of the people and companies currently locked out of employment. The problem is the time they have bought by slowing the spread of the virus has not yet produced a vaccination that would allow the all-clear to be sounded alongside near-universal vaccination. Some countries may decide their health systems can now cope and they can intensify their trace and isolate strategies sufficiently to allow a more general return to work. Some will decide the danger is still too great and wish to extend their lockdowns to ensure the virus is better tamed. Reports from US hospitals in the disease hotspots show the system is under great demand pressure from Covid-19 patients. President Trump’s optimistic prediction that all could return to normal after Easter is long gone as a reality. April is now written off in most places, and discussions are shifting to early summer.

The duration of the extreme measures is still the most crucial question affecting economic prospects and asset valuations. There is also the question of what does the new normal look like once some of the restrictions are lifted? I will examine the different scenarios in more detail this week and set out further thoughts. Meanwhile, the advanced world continues to be a place where companies making and selling food and other essential items do well, as do any providing online alternatives to many of the things people did away from home before the period of isolation.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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