This commentary was originally sent to MFA clients on 02.02.2016
Financial markets have had a rough start to 2016 and it has largely been the story of two issues that came to a head in December 2015.
OPEC effectively abandoned its output quota at its December meeting, which served to accelerate the collapse in oil prices. The headline theory is that Saudi Arabia is determined to flood the oil markets in order to drive oil prices down and drive the higher-cost oil producers out of business. Presumably, at that point, the Saudis can cut production so prices will rebound. Furthermore, Iran is expected to add even more oil supply, as international sanctions are gradually lifted. Oil at $30/barrel has put higher-cost energy producers (from American frackers to Latin American drillers) under great financial strain and a wave of bankruptcies is expected. Distressed credit investors have been raising money and are increasingly vocal about the abounding “opportunities” for restructuring. Plunging stock and bond prices in the energy sector are partly to blame for January’s selloff, as the extent of sector’s importance is realized.
As widely expected, the Federal Reserve raised their target range for the Fed Funds rate by .25%. While a .25% increase does not have a huge economic impact, the symbolism cannot be overstated. The rate hike came after eight years of zero interest rate policy (ZIRP) and also marks a tightening of monetary policy. Thus, the first hike symbolizes both progress and a headwind. Despite an increase in short-term rates, long-term rates immediately began to fall and are now materially lower than when the Fed hiked. Although the Fed’s decision was unanimous, there is great debate among market participants about whether it was a prudent move and price action in the rates and credit markets have given some credence to the dovish camp.