Monday Musings: June 22, 2020

Jun 22, 2020


Public Trust Credit Team
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Oil lubricating path to economic recovery

This morning, the Wall Street Journal reported that the recovery in commodity prices points to economic recovery with the biggest driver being China’s increasing demand for raw materials and improving economic data in the United States also providing some support. However, stronger demand is only part of the story. Just a few months ago, commodity supplies were disrupted by the uncertain outlook for global health and global macroeconomics. Looking at crude oil, average daily production in Texas (the home of the Permian Basin) fell from 143.7 Mb/d in January to 122.7 Mb/d in March. OPEC production declined from 30.4 MMb/d in April and 24.6 MMb/d in May. Commensurate with the declining production, West Texas Intermediate (WTI) prices rose from $18.84/bbl in April to $40.06/bbl this morning per Bloomberg. Pricing for crude oil always reflects future expectations, so the best comparison of production and pricing would not be concurrent in the event of a exogenous shock. Similarly, average monthly prices for silver and copper have risen 27% and 19% respectively since March. These storable commodities are more closely tied to demand, further strengthening the case that the appetite for raw materials is improving. More data will be gathered from this week’s economic indicators including Markit PMI, new home sales, changes in wholesale inventories, jobless claims, personal spending, and consumer sentiment.

S&P 500 companies aim to keep cash balances elevated as they prepare to weather the uncertainty of a downturn

The Wall Street Journal reported this morning that U.S. listed companies are on track to raise over $150 billion in cash this quarter, surpassing the record $135 billion raised in Q4 1999. The most notable transaction this quarter was PNC’s divestment of its 22% stake in BlackRock Inc. for approximately $14 billion, a position the bank held for over two decades. Companies and leadership teams are faced with the economic fallout created by COVID-19 lockdowns and have put the need for liquidity and strong financial flexibility at the forefront of their immediate strategy. According to The Journal, S&P 500 companies have increased their median cash and cash equivalent position by approximately 13.9% in the March quarter relative to less than 4.1% in the prior three quarters. 
The high degree of uncertainty regarding COVID-19 paired with various economies strategies to deal with infections and the economic aftermath have left many companies focused on strengthening their financial flexibility by increasing cash, shedding costs, and entering the debt markets. The ability to access cheaper funding in the debt markets has fueled new issuance, with data provided by Bloomberg revealing U.S. investment-grade debt issuance is currently at approximately $1.24 trillion, already surpassing the $1.21 trillion mark in 2019. Additionally, deposits flowing into the U.S. banking sector, particularly on the corporate side, grew by more than $865 billion in the month of April alone, outpacing 2019’s full-year total. Companies drew down existing lines of credit and participated in the Paycheck Protection Program, later parking that cash with domestic banks, with the U.S. money center banks being the largest recipients of the deposit influx.

How are U.S. banks positioned to face the pandemic?

On Thursday, July 24, the Fed will release the results of its annual bank stress tests. Given the unusual economic environment, the Fed added three new scenarios that examine how the U.S. banking system would fare under different patterns of economic recovery:
  • A V-shaped scenario indicative of a rapid recovery by the end of the year;
  • A U-shaped scenario where the economic recovery would be slower; and
  • A W-shaped scenario that would capture a short-lived economic rebound followed by another severe economic shock later this year due to a second wave of containment measures related to COVID-19.
The results of this new sensitivity analysis will be released on aggregate rather than bank-by-bank. Positively, the largest U.S. banks entered 2020 in a position of strength with solid levels of capital and liquidity and extremely strong asset quality. This has made them well equipped to enter a downturn, but the health crisis remains very fluid and impossible to predict. This year, the Fed is also introducing the new Stress Capital Buffer (SCB) framework that is based on the February 2020 scenario and December 2019 balance sheets. To give the thirty-four banks subject to this year’s exercise sufficient time to understand their results and potentially adjust their capital plans, they were asked to refrain from publicly disclosing their planned capital actions and SCB requirements until after the market closes on June 29. Depending on how well they perform, some banks may be forced to cut their dividend after the regulatory stress tests results are made public. The Fed did note that it could potentially revisit capital requirements at a later date (presumably before next year’s regulatory stress tests) depending on how the economic situation evolves.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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