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Dollar Mixed, Oil Spikes as Markets Digest Saudi Attack

  • The weekend bombing of Saudi oil facilities continue to reverberate across global markets
  • The currencies of the oil producing nations are likely to outperform near-term
  • US rates continue to adjust ahead of the FOMC
  • UK Prime Minister Johnson is in Luxembourg today to meet with EC President Juncker
  • China reported weak August IP and retail sales

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The dollar is mixed against the majors as markets continue to digest the attack on Saudi oil facilities.  Yen and Loonie are outperforming, while Stockie and sterling are underperforming.  EM currencies are broadly weaker as risk-off impulses build.  RUB and KRW are outperforming, while INR and PHP are underperforming.  MSCI Asia Pacific ex-Japan was down 0.2% on the day, with Japan on holiday.  MSCI EM is down 0.1% so far today, with the Shanghai Composite flat after returning from holiday.  Euro Stoxx 600 is down 0.5% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 6 bp at 1.83%, while the 3-month to 10-year spread inverted 5 bp to stand at -11 bp. Commodity prices are mostly higher, with Brent oil up 8.5%, copper down 1%, and gold up 1%.

The weekend bombing of Saudi oil facilities continue to reverberate across global markets.  Brent oil spiked to as much as $72 per barrel before settling back to trade just below $66 as of this writing, a gain of nearly 10% from Friday.  Saudi Aramco reportedly lost about 5.7 mln bbl/day of output from the initial strike, though subsequent reports suggest about half that loss may be restored today.  President Trump has authorized the release of oil from the Strategic Oil Reserve.

There are several implications to the attack.  One is that political risks in the region remain high and likely to feed into risk-off impulses.  Yemen’s Houthi rebels claimed responsibility for the attack and promised more.  Many fingers have been pointed at Iran, with Trump saying the US is “locked and loaded.”  The second is that if it is sustained, the rise in oil prices should keep upward pressure on interest rates and inflation.

The currencies of the oil producing nations are likely to outperform near-term.  It’s worth noting that in the majors, CAD and NOK have the highest correlations with Brent oil. In EM, COP and RUB have the highest.  Other than those examples, we believe the risk-off impulses will continue to favor USD, JPY, and CHF at the expense of growth-sensitive currencies such as the Antipodeans and EM.

Support for DXY held again around the 98.0 level.  This is a big retracement level, the 62% objective of the August 23-September 3 rally.  US rates have clearly gotten the message from last week’s data and were trading Friday at the highest levels since early August.  Today, however, US yields have fallen from Friday’s highs due to safe haven demand.  The dollar should benefit from US higher rates and that is why we remain dollar bulls.

The regional Fed manufacturing surveys for September kick off with Empire survey today.  It is expected at 4.0 vs. 4.8 in August.  This will be followed by the Philly Fed survey Thursday, which is expected at 11.0 vs. 16.8 in August.  Manufacturing remains vulnerable, but this is just one sector of the economy.  There are no Fed speakers due to the media embargo ahead of the Wednesday FOMC meeting.

The US economy remains in solid shape.  The Atlanta Fed’s GDPNow model is tracking 1.8% SAAR growth in Q3, down from 1.9% previously.  This is slightly below trend (~2%) as well as the revised 2.0% SAAR in Q2.  Elsewhere, the NY Fed’s Nowcast model is tracking 1.6% SAAR growth in Q3.  Its forecast for Q4 growth remains at 1.1% SAAR.

US rates continue to adjust ahead of the FOMC.  In the Fed Funds futures market, a little less than two cuts are priced in for the rest of this year, followed by a little more than one cut next year.  At the start of this month, the market was pricing in 2-3 cuts for both.  The market is nearly certain the Fed will cut this Wednesday.  We say nearly because for the first time since late July WIRP suggests less than 100% odds of a move.  Granted, they remain high at 98% but it’s clear to all that the US economy remains resilient and far from recession.  We think it’s a much closer call than markets appreciate.

UK Prime Minister Boris Johnson is in Luxembourg today to meet with European Commission President Juncker and discuss a “rough shape” of a Brexit deal.  Any breakthrough seems highly unlikely but expect some vaguely positive headlines to emerge.  Optimistic comments last week helped sterling get some traction, but markets await concrete signs of progress.  Juncker expressed doubts over the weekend that Johnson would present anything new.

Cable is trading at the highest level since July 22 near $1.2525 and is on track to test the $1.26 area.  After that, the next big target is the June 25 high near $1.2785 but it will likely be tough to reach in the absence of any real news.  The 200-day moving average near $1.2740 should also prove to be strong resistance.

China reported weak August IP and retail sales.  The former was expected to rise 5.2% y/y and the latter by 7.9% y/y.  Instead, they rose 4.4% and 7.5%, respectively, with both decelerating further from July.  It’s clear that the trade war is taking a toll on the economy but policymakers are hunkered down for the long haul.  Working level teams from the US and China will meet this week to lay the groundwork for higher level talks planned in October.

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About Win Thin
Win Thin
Win Thin is a senior currency strategist with over fifteen years of investment experience. He has a broad international background with a special interest in developing markets. Prior to joining BBH in June 2007, he founded Mandalay Advisors, an independent research firm that provided sovereign emerging market analysis to institutional investors. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983. Feel free to contact the Zurich office of BBH
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