Key Saudi Oil Site Attacked, Sending Brent +$70
Oil prices have spiked higher this morning after Iran-backed Houthi rebels unleashed a coordinated attack on Saudi Arabian oil facilities and military bases.
With OPEC pursuing a tight oil policy and US shale oil inelastic supply response to higher prices, any disruption to the Middle East supply chain could shoot oil prices considerably higher. Indeed, this could be the flashpoint that ignites that smouldering Middle East powder keg as apparent lines in the sand got crossed when the attacks targeted civilians. So far there have been no reports of significant damage or oil supply chain disruptions but this an evolving story that will keep oil traders on their toes.
On top of the terrorist attack, oil prices are also buttressed this morning on the back of data surprises, while the robust US jobs data demonstrates once again that the economy is poised to accelerate as the risk from Covid-19 recedes. China’s robust export data points to strong global demand, suggesting the damage of mobility restrictions is starting to fade.
US10y yields finished little changed on Friday at 1.57%, though that came after spiking as high as 1.62% immediately after the stronger than expected payrolls print. US equities ended higher, S&P up 1.9%. Oil was up a further 3.5%.
The bright finish in US equities on Friday may set the broader tone today. Despite the debate on inflation, tactically, everyone should feel reassured if higher yields are driven by growth expectations improving rather than market-based inflation repricing.
With interest volatility at the centre of everyone's concern, thankfully, the beat on US payrolls provided welcome relief for equities and points to an inflexion in the labour market. The stronger-than-expected print demonstrates once again that the economy is poised to accelerate as the risk from Covid recedes.
Also helping assuage some of the yield fears, China's exports accelerated and far exceeded market expectations, pointing to strong global demand and suggesting the damage of mobility restrictions is starting to fade.
The prospects for a turbocharged recovery in US consumer spending have increased with the passage of the Democrats $1.9 trn fiscal stimulus proposal and a rapid vaccine rollout that leaves the consensus forecast for 2021 US GDP growth 4.9% as much too pessimistic.
The market may be making more of a meal on yields than the Fed. And perhaps Powell and Co will view a shakeout, especially in the frothy equity markets, as a good thing as long as financial conditions don't tighten too much.
Still, the strong momentum in macro data heading into likely Q2 accelerating will make it increasingly challenging to keep markets from getting ahead of the Fed curve represented by the dot plots, for instance, as the market has already priced in 2023 hikes versus the Fed.
And this week, the markets will have to go it on their own as the pre-March FOMC blackout period means investors are left to their own devices until the next FOMC meeting on March 17.
But most participants welcome a move to higher rates as the front end remains awash in cash. Despite the volatility in rates out the curve, the 2yr note remains range-bound, and bills are virtually unchanged.
The pre-eminent macro question for the United States in 2021 is this: Will the medium-to-large burst of inflation and economic activity that is practically baked in the cake for the next six months be durable or transitory? Will it be a quick spurt or a long boom?
I don't think we can know yet, but putting pieces of this puzzle together will be the overriding theme for "Macro" in H2 2021.
On top of the OPEC surprise and terrorist attack on Saudi Arabia, oil prices are also shifting higher this morning on the back of data surprises.
While the robust US jobs data demonstrates once again that the economy is poised to accelerate as the risk from Covid recedes, China’s robust export data points to strong global demand and suggests the damage of mobility restrictions is starting to fade.
Oil prices and traders alike have booked a one-way ticket higher since OPEC+ surprised the market by keeping its production quotas unchanged for April, allowing oil to take the flyover route for the start of the main reopening surge in Q2.
Although members discussed Covid-19 demand risks, the primary takeaway is that shale producers remain highly inelastic to prices due to capital constraints, allowing OPEC+ to rule the supply roost and punch their ticket higher for oil prices. Meanwhile, the US oil rig count is up by one unit to 310 wells, the highest since last May but still not at a level that will upset the current supply and demand apple cart.
OPEC's supply strategy continues to work because, by catching the market by surprise, traders are left to play catch up to OPEC's conservative demand expectations.
OPEC is now clearly pursuing a tight oil market strategy. That’s causing several oil traders and bank analysts to raise their price forecasts for Q2 and Q3, which is finding a strong echo in market sentiment to the extent that not even a stronger US dollar could derail this runaway locomotive.
The key takeaway on the US dollar – and why it is not bearish for oil in this situation – is that the USD is getting stronger not for safe haven reasons but rather because traders are pricing in a US economic boom, which will create a massive uptick in demand for gasoline. The USA is the most services-heavy economy globally, and once the reopening narrative goes full swing, that will provide the icing on the cake. And the cherries on top will unquestionably be the 1.9T of stimulus passed in Sunday’s massive US infrastructure package.
On the macro front, US payroll data point to an inflexion in the labour market; the stronger-than-expected print demonstrates once again that the US economy is poised to accelerate as the risk from Covid-19 recedes.
The street’s short dollar recommendations came under further pressure over the past week on remarks from Fed Chair Powell and Friday's solid jobs report. Ultimately, the US dollar is all about repricing the Fed hikes up to 2023 because when FX traders start bringing forward rate hikes to the next two years, this matters for the US dollar.
More significant pushback from other central banks (RBA, RBNZ, ECB) has provided some respite to their respective bond markets over the last week and have given reason for the dollar move to broaden out.
A key question for the March FOMC meeting is how participants will revise their economic and interest rate projections to reflect further fiscal stimulus. At the time of the December 2020 meeting, participants would likely have assumed that the Phase 4 fiscal package would pass but would not have believed that Democrats would win control of the Senate and pass additional budgetary measures.
The clock continues to tick on an extension of the reserve/treasury exemption from supplementary leverage ratio (SLR) for USD bears. Front end concerns over the Fed's lack of commentary on the upcoming expiration of relief from the SLR disrupted the short-term markets. However, the market consensus is for an extension. Despite Senators Warren and Brown's plea to deny the SLR relief extension, the street sees such a move as ill-conceived. Given the recent volatility in the UST market, an extension of the current arrangement makes the most sense at this time.
Japanese investors have net sold 3.6tn yen of foreign bonds over a two week period, the largest over the past 20 years, suggesting US yields have more room to reprice, and the unwind of currency hedges could also support higher USDJPY.
Gold prices have fallen consistently since February 25 and have been mainly on the defensive all year, shedding USD270/oz at one point since hitting year-to-date highs of USD1,959/oz on January 6.
The jump in the USD and 10-year yields on Friday, following the better-than-expected February monthly payroll number, initially made it look like gold was about to fall through the trap door. But, later in the day, gold managed to pare losses and stabilize in line with softening US yields and ended the week bobbing around USD1,700/oz. Some of this may be due to end-of-week profit taking and short covering. The market may have fallen too steeply, too quickly. Gold has been undercut by cheerful economic optimism over a robust economic recovery and faster than anticipated rises in bond yields.
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Today’s key charts focus on oil, where the recent rally has stalled amidst talk of a lift in sanctions and speculation of a production boost.