It would be easier if we could just know the right amount of oil futures backwardation. The literal answer for the question of what’s the correct level is the curve’s shape at any given moment in time. That’s a little too close to the theory of perfectly efficient markets for me. Whatever it may be, or could be, the WTI curve continues its recent twist.
This is not exactly a sign of impending doom, far from it. This may be nothing more than a truly transitory anomaly of supply or demand factors being corrected.
We look at it with a somewhat wary eye, however, because of context and what’s going on elsewhere in the commodity space. We’ve seen this before just four years ago. In July 2014, the WTI curve underwent the same kind of twist only with a bit more downward vigor, starting out much higher as it did. However you may wish to mark the ascent of the “rising dollar”, it was clear by that summer it was on.
And it was the one pivotal influence that didn’t factor in any mainstream analysis. The perfectly timed deflationary impulse was ignored and dismissed largely because of the labor market data. Economists don’t factor money or really financial conditions except by narrative of whatever the central bank claims it might be doing.
Back then it wasn’t so much the unemployment rate as the Establishment Survey (and JOLTS JO). To most people, including nearly all the Economists, there was no way anything could interrupt the Hollywood ending scripted for QE3. Janet Yellen said so.
While the “dollar” system was eroding underneath in 2014, in economic terms the US economy in particular seemed almost insulated from all that. In accounts like retail sales, there was a very clear acceleration that was at least consistent with the idea of recovery (as compared to the prior period since 2012).
In fact, that is an important point to consider when analyzing the current condition. It’s hard to put an exact start date on the eurodollar system’s turn, but if we use China and CNY it was closer to the beginning of 2014 than the middle when the dollar’s exchange value really took off (and oil dropped). Retail sales were up the best since 2011 the whole time the monetary foundation began its devastating shift.
For the month of June 2018, the Commerce Department reports today that total retail sales increased 6.27% year-over-year (unadjusted). That’s the second consecutive month of better than 6% growth, with May’s rate revised sharply higher to nearly 7%.
All that does, however, is solidify the comparisons to 2014. Then as now there was a mix of OK months with bad ones. There really weren’t any good numbers in either, at least not consistent with historical experience. Before 2012, 6% used to be the floor for any healthy economy rather than a level to get excited about.
That was another key observation about 2014, one that obviously applies in 2018 (setting aside any lingering effects of last year’s hurricanes on these current rates). The occasional 6% instead of 10% is an indication something still isn’t right. Actual recovery upswings won’t display such low ceilings.
But if we are going to go from that bad economy to a good and healthy one, there has to be acceleration first. This is the big hope of globally synchronized growth as a rhetorical device; that the increasing rates for things like retail sales could be a real trend based on some nonspecific synergy derived from all the world’s major economies for once on the plus side at the same time. The first step toward a meaningfully better second step.
If we go back to November 2017, again setting aside any hurricane aftermath arguments, retail sales growth is pretty much like it was in the latter part of 2014. In fact, retail sales grew by more than 6% in September 2014 and by more than 5% that October and December. Off in the shadows for all those OK months was the undercurrent of increasing uncertainty and monetary pull.
There is one key difference, though, between that period and the current one – oil. Because the WTI curve was already in contango with the whole crude complex plummeting in December 2014, retail sales outside of gasoline were actually much better than they had seemed overall. Though total retail sales were up 5% in that month, excluding the 13% decline in sales at gasoline stations retail sales actually gained more than 7%.
They would repeat that rate in January 2015, too, where retail sales ex gasoline rose 7% in two consecutive months. In these very narrow terms, it may have seemed as if Economists might have been right in ignoring the oil signal (supply glut) and what it might have meant for the economy (boost for consumers!)
It was almost a full year into the “rising dollar” before consumer spending would begin to buck the consensus and start to show the clear signs of the eurodollar’s deflationary drag. The media wouldn’t alter its economic descriptions no matter what followed, always calling especially retail sales “strong” even though what followed January 2015 was more than a year of some of the worst months in the entire series (only those during the Great “Recession” were lower, and only one or two months during the dot-com recession were as bad).
In June 2018, in sharp contrast to December 2014 and January 2015, retail sales at gasoline stations are up 20.8% year-over-year. They rose 18.7% in May.
If we take account of these differences, excluding gasoline stations retail sales are appreciably lower now than in 2014. In fact, there isn’t as much improvement from even 2017 without WTI’s backwardation influence.
This leaves us with two important factors to consider. The first is what may be a weaker American consumer now as compared to four years ago at the prior peak. It’s not a huge difference by any means, but the indication isn’t a good one particularly since 2014 wasn’t near enough growth (here or anywhere else) and acceleration to stave off Eurodollar Event #3, or the “rising dollar.”
The second point is time. Again, the economy seemed to be picking up while monetarily underneath it was eroding the whole while. We can’t really know ahead of time when the two diverging trends will converge, so all we can do is observe the escalating monetary warnings and expect that at some point perhaps inevitably they will.
In terms of our eurodollar cycle, the US economy like its Chinese counterpart still appears to be in the green though more and more looking like on the downslope rather than upslope side. That, too, would be in keeping with 2014’s pattern. While the “dollar” part may already be red, maybe even deepening red, the economy can continue to disappoint (taking too long transitioning from narrative to data) for some time longer before it really turns. An increasingly likely Eurodollar Event #4 could grow truly serious all the while the economy can appear unbothered by it – until it is.
That was 2015.