In the post-financial crisis world, what is the new normal? Without looking back at the trash heap of financial disaster history or forecasting, let's attempt to take the temperature of the current environment.
This past Friday, crude futures trading volumes on both CME and ICE hit record highs and traded in $4-plus ranges with lows under $70/barrel on a day when the Dow Jones Industrial Average fell below 10,000 -- a comfort zone equities seem to have clung to after climbing out of the abyss of the recession's deepest trough. Still, this writer wonders if we're still on a macroeconomic roller coaster. Are markets at times hypersensitive and subject to false trigger, or at other times inured to underlying fundamental realities? Both?
Barack Obama commented during his recent State of the Union address that as a result of the bank bailout, financial markets have stabilized. But, overall, what is the definition of stable in the post-financial crater world? Are there some symptoms of ongoing fragility? And, when I say symptoms, I'll also include reactions or proposed reactions by government to the woes of this financial phase.
Times are still mighty tough when there is a rapid-fire succession of big news. For instance, at the moment we at Platts blasted a series of news flashes on the CTFC last month proposing limits on energy positions, I watched the simultaneous breaking news coverage of that on CNBC. But that itself was broken through immediately by CNBC also reporting that Fed Chairman Bernanke just urged the Senate Banking Committee to let the Fed remain a bank regulator. That particular double-bang gave me pause even though over the years I have become used to the never-ending big news cycle.
There are other signs the ground continues to shift as the Obama administration moves to limit banks trading in commodities, academics warn of a danger with see-saw hedging in oil and currency trading and the CME defending the merits of West Texas Intermediate as an oil benchmark.
CME commissioned two studies of oil benchmarks and their performances over time, with the authors coming out to maintain that WTI remains a strong, valid benchmark. The financial crisis presented "really unprecedented volatility in crude oil" trading, Craig Pirrong, a University of Houston finance professor, said at a recent CME press briefing in Houston. This included a "substantial contango" in WTI and Brent, largely owing to a demand drop shock, Pirrong said, and over time during the crisis, the relationship between stocks and WTI were "consistent with basic economics." But Brent spreads were "hard to square with economics" because when stocks were falling, Brent was in contango.
An author of the other CME-commissioned study, Kenneth Miller, vice president of the Purvin and Gertz consultancy, said criticisms of WTI as a benchmark "have been exaggerated" and betray "misunderstandings." Oil markets have been historically volatile, resulting in different trade flows and dynamics, and the Cushing hub--the delivery point of the NYMEX light sweet contract--has continued to expand, thereby increasing interest in the contract, Miller added.
What CME gathered from the studies is that WTI's performance as a benchmark shows it should keep its stature, said Robert Levin, CME's managing director for energy research and product development. "What we have learned was WTI continued to respond in some very strong ways the way we would like it to" in terms of convergence, transparency and fundamentals, he said. "It reflected the fundamentals the way it's supposed to."
Others still have concerns about additional factors. Delving into the relationships between dollar trading and oil markets, Rice University professors Mahmoud El-Gamal and Amy Myers Jaffe co-authored a book, Oil, Dollars, Debt, and Crises, The Global Curse of Black Gold. They say the combination was unhealthy enough to cause the surge to $147/b, the subsequent plunge and warn there could be a relapse.
While others may note that CFTC data shows that financials were on their way out of oil futures while the contract prices kept rising, Jaffe offered a tree analogy. As more and more people go out on a limb, including retail investors, the traders at the base hear a crack and get out of the way. "We're going to see it again," she warned at a book presentation last month. Gamal, an economist, and Jaffe see some hedge fund trading sentiments as self-fulfilling prophecy. Financial investors know that the "trend is their friend" and when they buy into something, it goes up, Gamal said.
Often, he says, these traders are waiting for a news item to trade on, a flash goes out and, "Voila, we created that trend and the trend is our friend." Derivatives are "great" for managing financial risk, but they "can be used for gambling," Gamal said. Are we all in?
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