Waiting for the FOMC’s good oil | Daily Market Commentary with Jeffrey Halley
Drowned out in a glut of oil headlines overnight, the FOMC two-day meeting starts today in the United States. As well as a slowing global economy made worse by the U.S.-China trade war, the Federal Reserve rate-setting committee now has to contend with the possibility, of sharply escalating tensions in the Middle East and the ramifications of possible shots being fired across the Straits of Hormuz.
The FOMC meeting will almost certainly concentrate on the bigger economic picture instead, and not get itself involved in the political chest-thumping sweeping the globe. The data from the United States is frankly, not that bad, but the Federal Reserve will not want to be caught wrong-footed and behind the curve, so to speak. Tomorrow’s rate decision will almost certainly be another 25 bp cut, but the critical factor will be whether it is another “mid-cycle adjustment,” or a move to an output easing bias.
The former will undoubtedly incur the wrath of the U.S. president who thinks rates should be negative now. That said, he seems to be angry with everyone. The later will almost certainly set off a wave of new easings by other central banks, as the United States had been the last man standing in the global slowdown. It will be particularly the case with emerging and developing markets, most of whom run some sort of USD peg or pseudo peg against their currencies. No export-driven country is going to want to lose market share in a contracting international market because their currency was too high against the dollar.
It will be a blessing in disguise that China is in the midst of a trade conflict with the United States. The big boy of the developing market grouping has precious little room to move on the devaluation front because of it and will have to let those annoying free-market forces do the job more gently for it. To be fair to China, they have been a rock of stability in times of trouble such as the late 1990’s Asia crisis, when they would have been entirely within their rights to jump on the competitive devaluation bandwagon.
The dollar bears waiting in the wings for the FOMC, may get their wish if the committee cuts and Mr Powell changes to an easing bias. That feeling of “I told you so” probably won’t last however as the rest of the world continues easing. As the dust settles, the realisation will be, that despite an easing bias’ the United States will still have the highest interest rates in the G-10. Far away from the $15 trillion oil slick of negative-yielding sovereign debt floating on the ocean of the worlds capital markets. Dollar strength is likely to persist for the rest of 2019, even after the FOMC gives us the good oil on the future direction of U.S. interest rates.
I have been asked extensively over the last 24 hours about my most significant worry for global oil markets from here following the gulf-war like jump in prices yesterday. Both Brent crude and WTI is holding their gains to finish 13% higher overnight. The answer is, of course, military retaliation against Iran. The satellite photos of the attack show a strike of military precision and execution, not the work of a group of poorly equipped rebels 600km away in the mountains of Yemen.
The U.S. President has accused Iran of being the perpetrator. The Saudi’s though, have been silent, with no concrete evidence yet offered. Despite the circumstantial evidence, I feel the barrier of proof would have to be very high indeed. Almost impossibly so as there are zero appetites in the world for a military conflict with Iran. A more likely course of action is a ramping up of sanctions on Iran. The chances of a military response by either Saudi Arabia or the U.S. are low. What is clear is that Saudi Arabian oil infrastructure is more vulnerable than thought, and a risk premium will be built into oil prices going forward.
Wall Steet finished lower overnight but only modestly so. Energy stocks soared while airlines and transport, unsurprisingly, suffered. The S&P 500 fell 0.30%, the Nasdaq fell 0.285, and the Dow Jones fell 0.53%. The Australian ASX is flat as we await the return of Japan from a public holiday yesterday. The Nikkei is likely to move lower, reflecting yesterdays price action elsewhere.
The rest of Asia will likely open steady having led the falls yesterday, preferring to look ahead to a probable easing by the FOMC tonight. The street will be vulnerable to Saudi Arabia related headlines following the chaos of yesterday.
The dollar strengthened overnight in a broad-based but orderly rally with the dollar index climbing 0.27% to 98.62. Investors rotated out of G-10’s and EM currencies to the greenback on Middle East tensions and the possibility of military escalation there. A war, or the possibility thereof, almost always elicits a dollar rally, morbid as that may sound.
Regional currencies will remain under pressure today as investors continue to reassess their risk parameters following the weekend’s events in Saudi Arabia and ahead of tomorrows FOMC decision.
Both Brent Crude and WTI finished 13% higher in New York, holding onto the majority of their Saudi Arabia inspired gains from the start of trading in Asia yesterday. Brent Crude is trading at $68.20 a barrel and WTI at $62.00 a barrel as Asia’s day commences.
The 5.7 million barrels of production taken offline by the weekend’s attack can, for now, be met by reserves in storage. What is not clear is how long the Akqaiq complex will offline. Saudi Arabia is the worlds only major swing producer, able to ramp up production by millions of barrels at short notice. Most of the other spare capacity, unfortunately, is in Iran and subject to sanctions. It has also carried the weight of most of the OPEC+ production cuts.
With the rest of the world producing at near-maximum capacity, another supply shock in the near-term would have material implications for the price of oil. The attack also highlights the vulnerability of Saudi Arabia’s oil infrastructure. For these reasons, oil prices are likely to remain elevated and may get another boost tomorrow if the FOMC moves to an official easing bias.
Gold rose 0.70% to 41499.00 and ounce overnight having reached as high as $1512.00 an ounce in the panic of yesterday mornings Asia session. The failure to close above $1500.00 will disappoint bulls as the Saudi Arabia attacks are the bread and butter of gold rallies.
A repid deescaltion of the Middle East situation may not be kind to gold given its underwhelming rally overnight. The FOMC nmoving to an easing bias may also be, to some extent priced in meaning a non-rate cut decision could see long positioning sharply reduced.
The $1480.00 an ounce area continues to be critical support and could be threatened post a disapointing FOMC. That would open up the $1450.00 area. On the topside, resistance appears at $1512.00, the overnight high, and $1530.00.