One key decision down and two more to go before the end of the year. The Opec agreement to cut oil production over the weekend marks the first of three important policy decisions being made this month. The other two will be about Brexit in the coming week in the British Parliament and about US interest rates in the following week by the US Federal Reserve.
The Opec deal was clearly more than the markets were expecting, with crude oil prices rallying 5 per cent on the news. Opec and its partners, most critically Russia, will cut production by 1.2 million barrels per day for six months, with Opec countries taking 0.8 million bpd of the cuts.
The agreement effectively unwinds the increase in production that Opec instituted at its last meeting in May. Since then production has increased steadily from producers that had the capacity to do so: Saudi Arabia, the UAE, Iraq and Russia. The latest deal sees Opec trying to manage the optics of the oil market carefully: cutting from October 2018 production levels means that several countries will be cutting from near record high output and avoid drastic damage to domestic economies.
A cut of 1.2 million bpd will help to alleviate some of the stock build anticipated for 2019 and in the near term will help keep prices from extending their 30 per cent decline from October peak levels. But with a market surplus of 1.5 million bpd forecast for the first quarter of 2019 the cuts won’t be enough to completely offset the build in inventories. Opec members such as Saudi Arabia will also be counting on supply disruptions from countries like Venezuela, Iran and now Canada to persist in order for these latest cuts to have an impact.
In the coming week the highlight of course will be the UK Parliament’s vote on Theresa’s May’s Brexit agreement with the EU on Tuesday. The chances of it being passed on the first attempt are very low, so it will be the scale of the defeat that will matter to markets.
A narrow loss might allow Mrs May to save some face to fight again, and perhaps to negotiate a few amendments to get it passed on a second vote. However, a heavy loss could bring down her leadership and make the Brexit process appear in chaos, which in the first instance would likely see the pound lose further value. Whether these losses are sustained, however, will depend on what happens next.
Most likely it will be Parliament itself that will take the initiative away from the UK government to manage the Brexit process, and this could result in a number of outcomes, not all of which are negative for sterling. In particular, it is possible that another deal is constructed, and/or that there could still be a second referendum. It may also happen that the deadline for Brexit is extended from March 31 to allow a new deal to be crafted. Any of these outcomes means that the upcoming week’s decision will not be the end of the issue, far from it, and that Brexit will continue as a focus of uncertainty well into 2019.
The third important policy decision to be made before the end of the year will be the Fed’s on December 19. US jobs data on Friday, while showing a slowdown in jobs growth in November, also showed that wage pressures are continuing to build. This should make a decision by the Fed to raise interest rates in less than a fortnight relatively straightforward. But again it will be what comes after that will determine how the markets respond.
Investors have already revised down sharply their expectations for monetary tightening in the US over the past month, amid a weakening of inflation expectations and worries about global growth. As such it will be the messages from Jerome Powell about the future path of rates that will be crucial for the markets, and following that it will be all down to the data.
None of the decisions being made this month in Vienna, London and Washington will bring finality to the issues that they address, but they are all important in shaping the way the markets will perceive them as they approach the coming year.
Tim Fox is the chief economist and head of research at Emirates NBD