E The Daily Shot And Data – January 25, 2016

The risk asset bounce we discussed a week ago finally materialized on Friday as more short-covering ensued. This type of volatility is likely to continue. Since crude oil now drives much of the market sentiment, let’s begin with the energy markets.

The figure below in yellow is not a typo. Brent crude rallied over 10% on Friday and is some 19% above the mid-week lows. This jump in oil prices sent shares sharply higher.

Source: barchart

Overall market sentiment however remains terrible and contrarian investors are suggesting that risk assets will climb the “wall of worry”. Here is the Credit Suisse Global Risk Appetite Index.

The relationship between crude oil and equities has been amazingly tight recently – which remains a puzzle.

Source: barchart

Below are some potential explanations – none of which seem particularly satisfactory:

1. The collapse in prices has been so precipitous, the implications for corporate credit are not yet clear. Can energy credit problems spill over into other areas?

2. Sovereign credit of some oil producing nations is at risk and could have geopolitical and market ripple effects.

3. The squeeze on fiscal positions of some oil producers is forcing sovereign wealth funds to liquidate their public equity holdings (petrodollars returning home).

4. The collapse in oil prices could trigger a global deflationary spiral, hurting share valuations.

We will have a survey on this shortly and we would welcome other potential explanations.<!–

By the way, here is why deflation risks have risen as a result of the weakness in oil prices. Here is a chart comparing inflation expectations and crude oil.

Source: Credit Suisse

Continuing with crude oil markets, below is the latest US oil rig count. Of course these days it’s less about rigs and more about wells, but it’s a helpful indicator nevertheless.

Source: @SoberLook, Baker Hughes

Speaking of deflation, Oxford Economics doesn’t see deflation in the Eurozone in spite of the collapse in oil prices. Perhaps.

Source: @OxfordEconomics

Dr. Draghi obviously doesn’t see it that way as he prepares the markets for further easing. The euribor futures are pricing in another ECB rate cut – deeper into negative territory. The second chart below shows the German 1-year yield near record lows – also pricing in a rate cut.