FX

November 26th, 2014 7:24 am | by John Jansen |

Via Marc Chandler at Brown Brothers Harriman:

Dollar Firmer and OPEC in Focus

– The odds of a substantial output cut from OPEC have slipped
– The continued fall in oil prices won’t do the ECB any favors in its battle to arrest disinflationary forces
– We continue to be impressed with the legal, political, and operation challenges of a sovereign bond purchase program in the EMU
– With the new economic team for Brazil all but confirmed, the government is preparing for some budget tightening

Price action:  The dollar is mostly firmer against the majors.  The yen and sterling are outperforming and up on the day, while Aussie and Nokkie are underperforming.  The euro is trading near $1.2450, while cable is trading just above the $1.5700 area.  Dollar/yen is holding right below the 118 level.  AUD is making new lows for this move below .8500, and with Kiwi holding up OK, the AUD/NZD cross made a clean break below the 200-day MA near 1.0915 and is trading at levels not seen since July.  EM currencies are mostly softer, with RUB, ZAR, and TRY leading the losers.  KRW and BRL are up modestly and outperforming on the day.  MSCI Asia Pacific is up 0.3%, the fourth straight gain as gains in China outweighed modest losses in Japan.  Euro Stoxx 600 is up 0.2% near midday, while S&P futures are pointing to a higher open.

  • The capital markets are mostly quiet, amid a light news stream, and ahead of three key events in the coming days.  US markets are closed tomorrow and light participation is expected on Friday.  These events are tomorrow’s OPEC meeting, the flash euro area inflation reading on Friday, and month-end portfolio and hedge adjustments.  
  • The odds of a substantial output cut from OPEC have slipped.  The Saudi oil minister continues to play down the need for output cuts, apparently on the grounds that to stabilize the market, more OPEC cuts are necessary.  Although there were some suggestions that Russia could cut output to help facilitate an OPEC cut, they were not seen as particularly credible.  A Rosneft official was quoted on the newswires indicating Russia does not plan on reducing its output.  
  • Simply put, as a cartel, OPEC ostensibly is interested in keeping prices higher than they would otherwise be.  However, for numerous reasons, OPEC is not the price setter it once was.  Especially with the rise of US output, there has been a significant shift in the underlying fundamentals, and this requires a new strategy.  Essentially, prices may have to fall to levels that begin curtailing production in a significant way.  This is seen as closer to $70 for Brent and $60-65 for WTI.  
  • Part of the challenge is that in industries that have high fixed costs, which in this case may be more a function of fiscal need than the cost of production, there are incentives to produce even at a loss.  Or worse, increase production in the face of falling prices to try to preserve revenue levels and market share.  Of course, this serves to exacerbate the problem.  
  • The failure of OPEC to indicate a serious cut in output will likely encourage fresh selling of oil.  This would likely support sovereign bond markets and could support equity markets, outside of energy.  It may mean little relief for high yield bond market indices for which energy sector bonds account for a significant part.  
  • The continued fall in oil prices won’t do the ECB any favors in its battle to arrest disinflationary forces.  It will report the flash November CPI on Friday, ahead of next week’s ECB meeting.  Although some economists/analysts are predicting a sovereign bond purchase plan will be unveiled, we are less sanguine.  We understand recent comments as indicating that a consensus favors waiting until next year to see the second takedown of the TLTRO, which is expected to be substantially more than the first, and the covered bond and ABS purchases.  
  • We continue to be impressed with the legal, political, and operation challenges of a sovereign bond purchase program in the EMU.  Moreover, we can’t help but wonder if all this speculation of sovereign purchases distracts from 1) the existing extremely accommodative stance – a negative deposit rate, full allotment of refi operations at a fixed rate just above zero –  and 2) the need for structural reforms to boost growth potential and support aggregate demand.  
  • The main economic news today has been the second look at UK Q3 GDP.  Although the 0.7% quarter-over-quarter growth was left unchanged, the details were disappointing.  Private consumption edged up (0.8% from 0.6%), but it was government spending that really was the standout.  Despite the talk about Tory austerity, government spending rose 1.1%.  The market expected a 0.2% increase.  Business investment fell 0.7% (a 2.3% increase was expected after a 3.3% rise in Q2).  Exports fell 0.4%, while the market had expected a 0.1% decline.  Imports jumped 1.4% after having fallen 0.3% in Q2.  
  • Sterling looks to be tracking short-sterling futures.  The December 2015 contract initially ticked up to new highs, but then reversed.  This coincided with sterling falling on the news, but then recovering back to session highs.  The key is $1.5740 on the upside.  A move through that area could see a quick move toward $1.58, were sellers are likely lurking.  
  • The dollar has lost some momentum against the yen.  Initial support is being tested near JPY117.70-80.  A break could force a bigger short squeeze in the yen and push the dollar toward JPY117.00.  Former MOF official Sakakibara has opined that the 14% fall in the yen since mid-year has largely run its course.  This echoes comments by some current officials, like Finance Minister Aso.  Separately, we note that Sakakibara warned that the LDP will likely lose more seats in the December 14 snap election than many anticipate.  According to newswires, he has intimated that a loss of 100 or more seats could force Abe to step down.  This would indeed be a shock to investors.  
  • Due to the holiday tomorrow, the US economic diary is chock-full today.  The initial focus will be on the volatile durable goods orders for insight into business investment.  Personal consumption and expenditure data will be helpful for economists to firm up Q4 GDP forecasts.  Note that the core PCE deflator is expected to be unchanged at 1.5%.  Later in the US morning, the Chicago PMI and University of Michigan consumer sentiment, and pending and new home sales will be reported.  The Chicago PMI is often correlated with the national figures, while the University of Michigan’s measure of consumer confidence is highly correlated with the equity market.  The drop in gasoline prices and improvement in the labor market may help as well to lift the measure toward 90 in its final read.  Small improvement is expected in the housing data.   The bottom line is that the slew of data is unlikely to distract from the US-friendly divergence theme.  
  • With the new economic team for Brazil all but confirmed, the government is preparing for some budget tightening.  It’s widely understood that Joaquim Levy will be new Finance Minister and Nelson Barbosa the new Planning Minister, and the announcement should happen on Friday.  What’s not clear is how much freedom they will have to enact the much needed fiscal tightening.  We expect some tightening to occur, but on a limited and gradual basis.  For example, local news wires report that the government is considering resuscitating a fuel tax.  In any case, the government will be in a tight spot between the weak economy as well as the impact of the corruption scandal relating to Petrobras and the country’s large construction companies.  For USD/BRL, one of the key questions is what will happen with the FX swaps program?  There are no signs that they are looking to unwind it yet, but if they do, it will pressure the pair higher.
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