The latest rise in oil prices may jeopardize the already complicated balancing act at the Fed (between containing manufacturing deterioration from the trade war) and Trump's managing of Saudi and Iran without provoking further price ascent. Yet, the US administration continues to send signals about reprisals against Iran and that helped crude to its 4th best day on record Monday. US crude oil is currently trading at $62 (from an earlier $63.38), while Brent is at $68.10 (from $71.95 earlier). CAD loses half of its gains as US equity futures head into the red. EUR is the strongest of the day after better than expected ZEW sentiment survey. Data points on Tuesday include US industrial production and homebuilder sentiment. The Premium JPY trade was stopped out, leaving only 1 trade in progress. A new trade shall be issued ahead of the US opening bell.
Oil finished Monday with an astounding $8 rally in the largest percentage climb since 2009 and fourth-highest on record. The attack on Iran sets in motion a wild amount of possibilities, including war between Iran and Saudi Arabia.
Trump's response has pointed the finger at Iran but stopped short of anything definitive. So far in his Presidency, he has largely ignored the drums of war and his firing of John Bolton underscored that just a week ago. Not to mention the fact, Congress is will unlikely authorise a strike on Iran.
Feel free to participate in this open discussion about oil, Trump, Fed & USD.
This time, he's hinting that action may be in order but his tepid response so far suggests it may be limited. That may mean a further escalation down the line but if so, the market will revert to a focus on fundamentals and the ability of Aramco to bring production back online. On that front, reports vary widely with some suggesting nearly all of it could be restored in two weeks while others say it could be months.
Oil Complicates Fed OddsExpect oil headlines to be a major factor in the days ahead but the Fed remains a key input. The odds of a cut fell to 95% from 100% a week ago. The oil jump complicates the decision because it creates a series of pros and cons. Higher gasoline prices for consumers and geopolitical uncertainty are negatives, but higher inflation and more investment/profits from US oil firms are positives. Ultimately, it's more of a reason to cut 25 bps as anticipated while sticking with a wait-and-see statement and message. Also, pay attention to the dissent and whether St Louis Fed president Bullard shall stick to his position of demanding a 50-bp rate cut after the oil spike.
Oil prices are up 8%, paring earlier gains of nearly 20% seen at the Asia open following the wide-ranging attack on Saudi oil infrastructure. The price spike signalled geopolitical worries rather than a loss of production. The chart below shows the attack caused the biggest supply disruption in history, exceeding supply shocks caused by the Iran revolution and the Arab oil embargo. JPY and CAD are today's FX winners, but gold and silver are up against all currencies, recovering from last week's metals slump. The Empire Fed (ISM from NY Fed) is due later, but world markets remain fixated on the US and Saudi response. Do not forget Tuesday's UK Supreme Court ruling on whether PM Johnson's prorogation of Parliament was legal. Then, all eyes shift to Wednesday's Fed decision and Trump's reactions. The Premium oil short was stopped out, leaving two existing trades in progress. New tactical Premium trades will be issued over the next two days.
Japanese markets were closed to start the week but that did nothing to stop a wild open. Brent rose as much as $11.70 to hit $71.95 – the highest since late-May. WTI hit $63.54. Dow and S&P futures were down by as much as 200 and 25 pts respectively before stabilizing.
The attacks cut Saudi production roughly in half, taking 5.7 million barrels per day out of service. Videos of the facilities showed massive fires and report said it will take “weeks not days” to fully restore operations. At the same time, some (if not most) of the production could be restored within a week.
Given ample supplies and reserves globally – including large amounts of oil in storage in Saudi Arabia – the moves in oil cannot be justified by fundamentals. Instead, it's the geopolitical risk that goes along with the attacks, as signified by the $20 jump in gold prices in early trading.
Houthi rebels in Yemen claimed responsibility for the attack, and if that's the case, it marks a leap forward in their offensive capabilities, proving a continuous threat to Saudi oil. The US, however, insisted on blaming Iran, which could lead to US and Saudi strikes in retaliation – something that risks sparking open war. US Secretary of State Pompeo openly pointed the finger at Tehran, but so far the President Trump has refrained from doing the same. If he does, it may signify an imminent reprisal. So far he has said the US is 'locked and loaded' for a response but wants to hear from Saudi Arabia first.
In FX, the Canadian dollar is the early leader with the yen and Swiss franc both attracting bids. The US dollar is generally stable elsewhere. It also adds a wrinkle to Fed thinking. Higher gasoline prices are undoubtedly inflationary but the attacks add a further geopolitical risk.
There are still some final data points for the FOMC to consider as well, including Monday's Empire Fed. The consensus is for a +4.0 reading.
We have been getting questions about exactly what's priced in for the ECB and it's not as straight-forward as it might seem. The euro dipped back to 1.1000 on Wednesday ahead of the decision and eurozone bond yields ticked lower. Along with the ECB decision also comes a key US CPI report. A new Premium trade has just been issued with 2 supporting charts & detailed notes.
There are five main moving parts to the ECB decision and that's what makes it so tricky. Let's break them down one-by-one.
1) Deposit rateThe headlines from the decision will be what happened to deposit rate, which is currently at -0.40%. The consensus is a 0.10% cut to -0.50% but it's far from assured. The OIS market is pricing in 14 bps of easing, which equates to a 40% chance of a 20 bps cut.
2) QEThis is a major wild card. The consensus of economists is for a new 30 billion per month bond buying program. However as series of speakers and 'sources' reports – including one last week from MNI – suggest that bond buys may be reserved in case of deeper economic problems. If that's the case, it might be signaled for October but the market reaction will depend on how clear that signal is.
3) Forward guidanceThe current guidance from the ECB is to keep rates at or below current levels at least through H1 2020. The consensus is for something like 'through mid-2020' but policymakers may find it easy to push that even further, especially if QE is left out.
4) TieringEurozone banks are struggling and one of the reasons why is that negative deposit rates and a flat yield curve crush net-interest margins. Tiering (expempting banks with particular reserves from negative rates) could alleviate the problem but it could also complicate it, creating winners and losers among banks. On Wednesday, Dutch parliament passed a motion against tiering in a sign of how difficult it will be to find a consensus. Economists expect some help for banks here but it's a wild card.
5) Verbal guidanceEven with all the moving mechanical parts, the press conference may be what determines the market reaction. Both the market and the central bank are pivoting towards a reliance on fiscal policy for euro direction. Draghi has emphasized this point since he started as President but we're fast approaching the time when the ECB is tapped out. Draghi may choose this moment to draw a line in the sand and say to governments with a more forceful tone that it's time to step up.
With all these considerations, handicapping the euro is difficult. Ultimately, we think right now that growth matters far more than the level of rates or miniscule changes in policy. The framework for viewing the decision may ultimately come down to how much confidence the central bank inspires that it can generate growth itself, or prod governments into doing more.