Did the oil shock end in January-February?

Commodities bottomed in January-February 2016 at lower prices than initially thought. Clearly, since then, commodity-sensitive assets have shown improvements almost everywhere. In the light of easing macro headwinds, we remain confident of avoiding a sharp slowdown in the foreseeable future. In turn, this leads us to expect a rising demand for oil. We know that the downward pressure on commodity prices since mid-2014 has been a supply rather than a demand issue.

Fundamentally speaking, there is little reason to change the view of a progressive rebalancing of the oil market during the coming quarters. Falling oil production in the US, in spite of a seasonal upward pattern, has pushed the price of oil (Brent) to the USD40/bbl level for the first time this year. Nevertheless, during the adjustment of the supply glut, the oil price should remain highly volatile. We know that oil stocks are at record levels, OPEC is producing at record levels and global growth uncertainties prevail.

Looking forward, and in the absence of a material shock to the world economy, we would expect the early-year bottom to put an end to the sharp decline in commodity prices initiated in mid-2014. We think that recent cross-asset market trends have legs. Our cross-asset investment conclusions are straightforward:

• We are overweight on High Yield bonds. The early-year spread-widening was led by the rising default risk in commodity-related sectors based on a bleak scenario. In our more constructive view, we see this embedded risk premium as attractive and as a protection should economic indicators soften;
• We are overweight on Inflation-linked bonds. The early-year decline in inflation expectations has gone beyond the drop in commodity prices. We view this as a temporary phenomenon and expect US consumer price inflation data to rise gradually, implying a re-rating of inflation-protected bonds over the course of the coming quarters. The Federal Reserve is likely to revise its inflation expectations upwards;
• We are overweight on emerging market debt, both in local and in hard currency terms, as a bottom in commodity prices should in particular help stabilize commodity exporters and put an end to a decline in the exchange rates;
• We are long on commodity currencies.