The blows just keep coming for financial markets, with Monday’s oil collapse stretching into Tuesday and piling on the stress for investors just barely managing to cope with coronavirus headlines.
Clearly, invoking a price war when Covid-19 was drying up demand for oil marked a “huge miscalculation by Saudi Arabia and OPEC+”, says a team of strategists at Jefferies led by Sean Darby, laying out a list of winners and losers from the crisis.
“The fact that the oil price drop contributed to the dollar doom loop will likely increase risk aversion within the financial system. It is set to cause a very deflationary backdrop requiring the central banks to be on the policy front foot in our view,” Darby says in a Tuesday note.
Even a month ago Darby’s team was warning that energy price moves were a ”zero-sum game.” Investors will see a first round of fallouts hit sovereign credit and currencies as inflation, fiscal and current accounts are altered. The second-round effects involve solvency of energy companies, deteriorating local credit conditions and lending by banks set against rising real consumer incomes.
Jefferies predicts severe sovereign risk for Middle East and North Africa [MENA] alongside other oil-producing nations, and expects high-yield credit risks will remain under pressure.
Many of those MENA oil producers need high break-even oil prices to meet fiscal goals, such as Saudi Arabia, whose stands at US$85. “Hence, lower energy prices provide a welcome boost to the consumer in service based economies, but will inherently increase the sovereign risk of oil producing nations,” say the analysts.
Investors can also expect to see sovereign and corporate credit risks trigger tighter financial conditions, coming just as global central banks have just engaged in massive and unprecedented monetary easing. Such “third-round” effects are tricker to gauge.
A loser for now is energy shares, of which Jefferies remains bearish. “The more challenging aspect of owning energy shares is not just the underlying solvency in the long-term but also justifiable concerns over dividend and buyback policies,” said Darby and the team.