London Open: Oil shock continues to buoy the USD

Market Analysis / 5 Min Read
Stephen Innes / 24 Apr 2020
A wall of stacked red oil barrels

London Open 

The oil shock continues to buoy the USD, albeit to a lesser degree for today dollar demand; for that we can thank a general risk malaise triggered by failed clinical trials of a high-profile anti-virus drug. 

Still, risk sentiment is holding up relatively well despite incredibly weak global PMI data over the past 24 hours that came in well below expectations in several cases. 

The combination of persistently low yields and rallying equities suggests investors expect central banks to remain in money printing mode and positioned fearless as central banks are unhurried about shrinking balance sheets. If that expectation is correct, US credit spreads should tighten further and EM equities are well placed to rally if concerns about a secondary spreader move to the back burner. 

Provided global inflation expectation remains muted, ASEAN bond markets have scope for further gain. In Asia, the high yielder like the IDR and INR are well-positioned and, with the BNM possibly moving the rate cut needle 100 bp lower in the next little while, the MYR could start to look well placed in these conditions.

Although the Ringgit was dealt with an untimely side swipe via and extended MCO order this morning, with oil prices stabilizing, the MYR should hold its own into the close.

A disappointing end to the Eurogroup summit without agreement elicited only a modest selloff in EURUSD expected, while a limited response at the European open would support this view. 

The Fed's swap lines were widely tapped in the last week. A total of $50.8 bn was drawn in the week of April 17-23 for an outstanding $432.3 bn. The ECB took $8.6 bn in the week; the BoJ took $24.5 bn, including a $19 bn single take. The Fed is to publish detailed information on participants and drawdowns from its crisis facilities. It said it would produce a monthly report with "substantial amounts of information" on the who and how much. 

WTI oil

The lack of action in WTI oil markets is as much about near contract technical mechanics is it is about tank tops. Still, of course, this lacks the necessary touch of sensationalism associated with most of the redundant "hot take" views on oil markets these days. With so many flaws related to trading NYMEX June deliverable WTI, the contract has devolved into a lousy bedfellow discounted proxy to the only game in town (Brent), as cross-asset correlations suggest the June WTI is soon to become irrelevant. This trader sees the market through an entirely different lens than the analysts. 

Distressed energy names caught a bid as crude prices again gained background, and the spread between the June and July contract narrowed confirming that view

As expected, US Treasury Secretary Mnuchin said, he’s looking at ways to support the US oil industry. In an interview with Bloomberg, he said he is examining whether there could be a lending facility for the industry. 

But, overall, I expect more demand-driven oil price moves to be the key driver of oil as global supply rapidly drops due to a combination of voluntary, forced and compensated shut-in. This view has possibly put tonight’s Baker Hughes rig count report on a more prominent pedestal than usual.

Thanks to the FT's Alphaville providing the useful educational backdrop for me to explain the influence of ETFs on the price action in oil of late. It’s helpful not only because it’s an excellent white paper to explain some of the market mechanics that hit oil (on top of storage factors), but also because it highlights the common misread of ETF data.

Inflows to ETFs are often used as an expression of positive interest, but that misses that ETFs can be short instruments as well as long, either by their structure (the XIV ETF a classic example) or through "create to lend" strategies.

The Euro 

The April flash PMIs confirmed a further sharp deterioration from already historically weak March levels. While the services sector remains most affected, manufacturing is starting to catch down with the collapse in servicing activity. Across countries, Germany is faring better than the rest of the EMU4, which is gingerly providing support to the Euro. Still, the prospects of an asymmetric recovery will challenge the design of the European policy response. And for the Euro this is where the confusion lies, given the constant inflight among EU members. 

The Yen 

The Nikkei headlines, which suggest the BOJ could go to unlimited bond-buying, should not fly with G-10 traders as being important. The BOJ was not buying anywhere close to the limit anyway because, under the YCC framework, they haven’t needed to. They haven’t been bumping against any quantitative limits. Furthermore, bond buying and QE-type announcements have had zero currency impact around the world anyway as far as currency markets policy transmission with Fed in the same boat.

The Aussie

The Australian dollar remains bid on dips, but it’s going take a double dose of positive domestic and China data to get markets tacking towards .6450. 

The Yuan

The People's Bank of China conducted CNY56.1 bn of 1y TMLF at 2.95% (Bloomberg). This is a 20bp cut from the previous rate of 3.15% and matches the 20bp cut to the 1y MLF rate on Apr. 15; a lower rate but smaller amount – quite a neutral move.

Onshore funding has been flush, so the PBoC seems to be lowering the rate to be in line with the earlier cuts without further injecting liquidity, and USDCNH is searching for a direction but will ultimately end up tracking the dollar direction into the weekend. 

Gold 

Tensions in the Middle East, worries about the economics of Covid19, another 4.4 mn people filing for unemployment benefits in the US, and the US manufacturing PMI weakening to 36.9 are among the reasons why gold has been able to bounce higher, even with the US dollar holding steady.

Although, as has been the case most of the week, early profit-taking in Asia continues today. But the continuation of global central bank stimulus will be supportive for bullion as real rates remain negative. Opposite to the glut in the oil market, there a shortage of physical gold which should provide underlying support.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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