Will Crude Oil Soar Again?

Commodity

Summary:

Crude oil retraced to 77.5. In the context of production cuts, concerns about a gap between supply and demand stimulated oil prices higher. So, oil prices are about to soar? Currently, the market is almost completely bullish. However, we need to stay rational moderately.

After Saudi Arabia and Russia greatly exceeded market expectations yesterday to claim to extend their production cuts until the end of the year, oil prices soared again, and the European and American markets rose rapidly to 87.5. The market is generally optimistic that oil prices will rise above the previous high of 93 as a gap is expected between supply and demand at the end of the year. However, what I would say is that the market is full of uncertainties. Therefore, we should be bullish, but avoid going long blindly. In this situation, it is difficult for oil prices to break through the previous high of 93 again merely based on expectations alone. The premise of the breakthrough is a fundamental positive stimulus, that is, the impetus of improved demand. As the supply side has reached its pushing limit if the demand side fails to keep up, then this bullish trend will probably come to an end. However, the pullback of oil prices yesterday may also indicate the market fears of being so high.

Let's start by reviewing yesterday's news. The "additional production cuts" of Saudi Arabia and Russia began in July 2023. The cuts were originally scheduled for a month but have been extended twice until the end of September. The three-month extension this time exceeded market expectations. Perhaps the market was not surprised by this, as this was the case in both early July and early August. July was the first time that production cuts were extended, and the market responded as it should. Oil prices smoothly rose for a month. However, for the August extension, the price increase only lasted until August 10, when there was a deep correction. Well, it is now the third extension of the production cuts, for 3 months unexpectedly. What kind of story will there be? Perhaps history is always strikingly similar.

From the perspective of OPEC+ producers, larger production cuts will help stabilize oil prices and thus maintain a balanced budget. Their determination is also unquestionable because it supports the ambitious spending projects of Mohammed Bin Salman, Saudi Crown Prince. Also, the "protracted" Russia-Ukraine conflict requires a stable oil price. The question is, will this strategy of "high price replacing high volume" drive oil prices to new highs?

There are several aspects we should notice about. On one hand, the oil production of Iran in August has returned to its record high in five years, with approximately over 3 million barrels per day, which has largely diminished the effect of the cuts. Saudi Arabia's further additional production cuts have brought its total crude oil production to about 9 million b/d from a historical peak of 12 million b/d. According to the monthly report released by the Saudi central bank last week, its foreign exchange reserves fell by more than $16 billion to about $407 billion, the lowest level since the end of 2009. Although there is a determination to reduce production, the space for further production reduction is extremely limited. Perhaps after the stabilization of oil prices, they will withdraw production cuts gradually.

On the one hand, one of the important factors in extending additional production cuts is that China's economic recovery is still worse than expected. China, the world's largest oil consumer, has launched a package of easing measures since August to stimulate the economy, and markets are betting that its recovery will be further delayed until the fourth quarter. At the same time, the global recession fears have not completely dissipated. Judging from the economic data of Europe and the US in August, the economic situation is not optimistic. Therefore, the market generally predicts a slowdown pattern in the fourth quarter in Europe and the US.

Personally, I reckon the extended production cuts are a response to the sluggish demand, which is a salvation to oil prices, not an icing on the cake. At the same time, it will also limit the rise in oil prices. Therefore, investors need to be wary of the possibility of profit-taking by bulls in the short term.

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Thomas

Economic

Stocks

Global investors looking for alternatives to China's anaemic economy are pouring money into India, picking stocks carefully in a market they abandoned in 2022 and still deem expensive.

India is attractive, investors say, because it is insulated from China while also emerging as a strong parallel offshore manufacturing hub, and it has a healthy consumer base. The market has traditionally done well in an election year, and general elections are coming up in April.

But popular blue-chip stock valuations are sky-high, forcing these investors to pick and choose sectors such as autos and technology, while avoiding banks and blue-chip firms.

India is not alone in drawing investors who are disenchanted with China's markets and an economy limping after years of pandemic lockdowns.

But the nearly $16.5 billion foreigners have poured into Indian stocks this year, their biggest splurge since at least 2008, eclipses the $8 billion and $5 billion received by South Korea and Taiwan.

"I think the Indian market is attractive compared to its regional peers," said Sukumar Rajah, director of portfolio management at Franklin Templeton Emerging Markets Equity, pointing to the country's attractive demographics, market-oriented economy, and rising middle class. Foreign Investors Rush into Indian Stocks as Locals Lie Low_1

Foreign Investors Rush into Indian Stocks as Locals Lie Low_1

Foreign Investors Rush into Indian Stocks as Locals Lie Low_2

Locals VS. Foreigners

The blue-chip S&P BSE Sensex and the Nifty 50 index are both up 8% this year, outperforming the 3% rise in the MSCI emerging markets stock index and a flat MSCI Asia-ex-Japan share index.

But both indexes are close to the record levels, making it imperative for foreign investors, who usually prefer larger companies, to be discerning.

For Kunjal Gala, head of global emerging markets at Federated Hermes, technology stocks are a "contrarian bet" on the U.S. tech sector recovering, but he also likes automakers and non-banking financial firms.

UK-based Aubrey Capital Management Portfolio Manager Rob Brewis focuses on consumer-focused companies, with his fund counting Varun Beverages as its top holding. The Pepsi bottler is up 41% this year, after surging an astonishing 123% last year.

"We've always taken the view that you get what you pay for, and it's the best growth story. It looks like it's going to keep going for several more years to come," said Brewis, referring to richly valued Indian stocks.

Foreigners pulled $17 billion from India in 2022.

Their return this year however coincides with a pull back by domestic investors, who have been the driving force behind the market's 150% rise from the pandemic lows in March 2020.

Data shows data domestic institutional investors put over $13 billion into Indian capital markets this year, compared with roughly $36 billion last year.

Pramod Gubbi, Mumbai-based founder of Marcellus Investment Managers, points to the froth in small and mid-capitalised companies, the segment most domestic retail investors get into. The small-caps index is up over 28% this year.

Local investors are now being tempted by traditional, safer savings options, as bank deposit rates have spiked since the end of 2022.

Yields on benchmark 10-year bonds are above 7%, while one-year bank deposits earn roughly 7%.

"Overall, equities start looking expensive versus other alternatives for domestic investors," said Sunil Tirumalai, an emerging markets and India strategist at UBS in Mumbai. Foreign Investors Rush into Indian Stocks as Locals Lie Low_3

Foreign Investors Rush into Indian Stocks as Locals Lie Low_3

Foreign Investors Rush into Indian Stocks as Locals Lie Low_4

Valuation Gap

Foreign investors have long been wary of India's rich valuations. The nearly $900 billion Sensex now trades at a price-to-earnings ratio of 22.6 times compared with 12.6 for the MSCI Asia-Pacific ex-Japan index.

Federated Hermes' Gala said his fund has trimmed its position since the start of the year to neutral in India.

"It's not that we are giving up on India. But... good quality companies, growth-oriented companies, the companies that we would ideally like to buy are not available at reasonable valuations."

Concerns over corporate governance are also deterring some investors, after U.S.-based short-seller Hindenburg Research accused the Adani Group in January of improper business dealings.

James Thom, senior investment director of Asian equities at abrdn, is overweight on India and has had a large position in the country for many years. He says China is cheap but not many investors are brave enough to bet on a rebound there.

"India stands apart as probably the most attractive macro story at the moment," Thom said.

Source: Reuters

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Devin

Central Bank

Economic

Three influential European Central Bank policymakers on Wednesday warned investors who are overwhelmingly betting against an ECB interest rate hike next week that the decision was still up in the air.

With euro zone economic activity deteriorating and inflation easing, although still high, the ECB is widely expected to bring a streak of nine consecutive rate increases to an end at its meeting on Sept. 14.

But the Dutch, French and German central bank chiefs, speaking on the last day before the ECB's self-imposed quiet period, said the Governing Council's decision was still open.

Dutch central bank governor Klaas Knot was quoted as saying investors may be underestimating the chances of a rate hike next Thursday, and that the decision would be "a close call".

"I continue to think that hitting our inflation target of 2% at the end of 2025 is the bare minimum we have to deliver," Knot told Bloomberg.

"I would clearly be uncomfortable with any development that would shift that deadline even further out. And I wouldn't mind so much if it shifted forward a little bit."

His French peer Francois Villeroy de Galhau hinted that a fresh rate hike could still come at a later date.

"Our options are open at this Council as at the following meetings," he told reporters.

"We are close, very close to the peak in our interest rates. We are however still far from the point where we could consider cutting them."

The Bundesbank's Joachim Nagel spoke along the same lines, saying next week's decision would depend, among other factors, on the ECB's new economic projections and that rate cuts were not imminent in any case.

"It would be wrong to bet on a rapid decrease in interest rates after the peak," Nagel told German business daily Handelsblatt.

Speaking to the Reuters Global Markets Forum last week, Austria's central bank chief Robert Holzmann said the ECB may still do another "hike or two" while Portugal's Mario Centeno said it needed to be very cautious about any further tightening.

Source: Reuters

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Samantha Luan

Forex

USD: ISM services the only threat to an otherwise bullish story

The relentless rise of the dollar continues. The DXY yesterday pushed up to the highest levels since March as U.S. yields once again edged higher. While the busiest day in U.S. investment-grade corporate issuance in three years has surely been weighing on U.S. treasuries, the FX market has also come under the spell of higher energy prices. The Saudis have this week confirmed their plan to roll over their 1mn barrels per day supply cut into December. This is keeping conditions tight in crude energy markets and now sees Brent trading over $90/bl. To FX markets, that provides an unwelcome reminder of the spike in energy prices last summer which had hit the energy-importing currencies in Europe and Asia.

U.S. energy independence and its net exporter status leave the dollar well-positioned for higher energy prices. It would seem the only real threat to the dollar in the near term would be some dramatic re-assessment of growth prospects. That brings us to the key piece of U.S. data this week – today's release of the ISM services index for August. A sharp fall in this series did weigh on the dollar at the tail end of last year, but unless this really surprises with a sub-50 reading today, expect the dollar to hold onto recent gains and consolidate at these high levels before the U.S. August CPI release this time next week.

In terms of G3 currencies, we might see some re-adjustment, however. Speculators still seem to be holding onto long euro positions, while they continue to run very short positions against the yen on the carry trade. USD/JPY upside now looks more limited as rhetoric from Tokyo threatens imminent intervention. Positioning suggests EUR/USD support levels are more vulnerable. EUR/JPY may now struggle to get over the 158.50 area and may be about to embark on a correction to the 155 area.

EUR: EUR/USD looks vulnerable

We are increasingly hearing the term 'stagflation' to describe the Eurozone economy. As a growth-sensitive currency, stagflation is bearish news for the euro and was one of the key factors weighing on it at its birth in 1999. Adding to that story is now the supply-driven spike in energy, reviving fears of last summer's negative terms of trade story for the euro. In practice, that meant the eurozone's traditional trade surpluses turned into deficits and the euro got hammered. With natural gas prices still very subdued, this energy story will not hit the euro as hard as last year, but it remains unwelcome.

Regarding European Central Bank (ECB) policy, the market prices just a 25% probability of a 25bp hike next week. We think the chances are much higher than that. However, speculative positioning and the energy story leave EUR/USD in a vulnerable position and EUR/USD could easily slip through support at the 1.0700 area in a move to the 1.0635/40 area.

Elsewhere in Europe today, we should see the start of an easing cycle in Poland. The move looks well-telegraphed and perhaps should not weigh too much on the zloty. However, the softer EUR/USD story and higher oil prices look to keep the zloty on the back foot near term.

GBP: Look out for BoE Governor Andrew Bailey at 3:15 pm CET

Sterling is coming under pressure against the strong dollar and marginally outperforming the pressured euro. High wage growth looks to be the primary reason for the market retaining expectations of a further 57bp of Bank of England (BoE) tightening in this cycle – making pivotal next Wednesday's release of the average earnings figures for July. Our base case is one more 25bp hike from the Bank on 21 September and then a prolonged pause.

The manufacturing slump in the eurozone and these high energy prices suggest EUR/GBP can trade at the lower end of that 0.8500-0.8600 range into that BoE rate meeting on 21 September. GBP/USD looks more vulnerable to a firm test of 1.2500 psychological support.

CAD: An unsurprising pause by the Bank of Canada today

USD/CAD printed the highest level since March yesterday, briefly breaking above the 1.3660 April high following another round of USD strengthening and generalised softness in pro-cyclical currencies. We don’t expect today’s Bank of Canada meeting to be a turning point for the loonie, as policymakers should take into account the recent weakness in growth and the cooling labour market and opt for a pause – here is our full preview.

The dovish move in market expectations has already happened and markets are expecting no change today, while a modest 9bp is left in the CAD OIS curve before year-end. This means that the downside risks for CAD from today’s pause should be limited, also because the BoC will likely want to avoid categorically closing the door to more tightening just yet.

The rise in USD/CAD in the past month has not been mirrored by a divergence in the USD/CAD short-term divergence of similar magnitude, and the pair is currently 2.5% overvalued according to our short-term fair value model. While a turn in US activity data likely remains necessary to pull the trigger on a USD correction and close the mis-valuation gap, we think that further USD/CAD gains will prove increasingly unsustainable. A retracement to the 1.3460 200-day MA is our preferred bias for September.

Source: ING

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Cohen

Bond

Economic

The US curve can't stay inverted forever. So, if rates don't get cut, long rates must rise

There are many theories swirling around as to why the US 10yr yield did an about-turn on Friday, post-payrolls. It had initially lurched towards 4%. But in a flash, it was heading back towards 4.25%.

We rationalise this based on two factors. First, the curve remains very inverted, with longer tenor yields anticipating falls in official rates in the future. That's a normal state of affairs. But as long as the economy continues to motor along, the wisdom of having many rate cuts at all is being questioned by the market. Less future rate cuts raise the implied floor being set by the Fed funds strip. That floor continues to edge higher. That's the second (and related) rationale.

Friday's payroll report was not one that suggested anything had broken. Rather, it hinted at more of the same ahead. There are lots of stories floating around about the rise in the oil price and heavy primary corporate issuance, but we're not convinced they are the dominant drivers. They certainly push in the same direction, but that's all – contributory rather than driving.

Until activity actually stalls, there is no imminent reason for the Federal Reserve to consider rate cuts, and as that story persists, the floor for market rates is edging higher and becoming more structural at higher levels. In that environment, the only way for the curve to dis-invert is from longer maturity yields coming under rising pressure as shorter-tenor ones just hold pat.

Something will break eventually, but so far it hasn't. The path of least resistance therefore remains one for a test higher in longer tenor market rates. Dis-Inversion from the Back End_1

Today's events and market views

Rates are drifting higher and a busy primary market is a technical factor – though usually fleeting – that has added to the upward pressure. But it is the data that has provided markets with the waymarks, although first impressions can prove deceptive.

Today's key data is the ISM services which is expected to soften marginally, suggesting the sector is losing momentum towards the fourth quarter. For now, it would not meaningfully alter the overall situation. Susan Collins, president of the Boston Fed, is scheduled to speak on the economy and policy. Later tonight, the Fed will also release its Beige Book with anecdotal information on current conditions in the Fed districts.

In the eurozone, we will get retail sales data for July. Yesterday, the European Central Bank's surveyed consumer inflation expectations saw a slight uptick, but this was balanced by downwardly revised final PMIs – the net impact on market pricing for the September ECB meeting was marginal. No ECB speakers are scheduled for today. In government bond primary markets, Germany taps its 10Y benchmark for €5bn.

The Bank of Canada will decide on monetary policy today with no change widely expected after the economy surprisingly contracted in the second quarter.

Source: ING

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Devin

Economic

Europe might need a miracle to repeat the "immaculate disinflation" currently gracing the United States. Across the Atlantic, price pressures are receding without a recession or massive job losses. The euro zone's export-led economy is weak, consumers and businesses are borrowing less, and higher borrowing costs mean there's further pain to come.

The contrasting fortunes of Christine Lagarde, president of the European Central Bank, and Jerome Powell, chair of the U.S. Federal Reserve, can be summed up in two numbers. The U.S. inflation rate in July was 3.2%, while GDP grew 2.1% year-on-year in the second quarter. The equivalent figures for the euro zone were 5.3% and 0.6%, respectively. Europe Faces Dirtier Inflation Fight than U.S._1

Europe Faces Dirtier Inflation Fight than U.S._1

It is a tale of two economies. In the United States, the Fed's steep increase in interest rates appears to have succeeded in guiding inflation towards the central bank's 2% target without causing a recession. The ECB's similarly aggressive tightening has been less successful in cooling growth in consumer prices, yet risks tipping the bloc into a downturn.

The 20 countries that share the single currency narrowly escaped a recession – usually defined as two consecutive quarters of shrinking GDP – earlier this year. Though economic output in the euro zone contracted by 0.1% in the final three months of 2022, the bloc recorded zero growth in the first quarter of this year, avoiding the technical definition of a recession by the narrowest of margins.

Yet recessionary risks are still lurking. The euro zone's manufacturing sector, which brings in around a fifth of GDP, is already shrinking. Factory activity in July fell at the fastest pace since the height of the pandemic in May 2020, according to a survey of around 5,000 firms by S&P Global. It recovered slightly in August but it remains at levels consistent with a recession. Weak demand for exports from China and the end of the post-Covid consumption spurt are forcing Europe's industrial firms to batten down the hatches. Germany's export-led economy, the euro zone's largest, will see GDP fall by 0.3% this year, according to the International Monetary Fund.

Activity in services, which make up the lion's share of the bloc's output, is also sinking, touching a 30-month low in August, according to the S&P Global survey. That's because demand for services like travel and entertainment, which boomed after the pandemic, is waning. As governments removed fiscal support and higher prices and borrowing costs hit consumers' finances, services firms suffered the worst slump in new orders since May 2013, excluding the pandemic years, in August.

The nine consecutive hikes in the ECB's policy interest rate since last year are also making credit scarcer and less desirable. The central bank found that companies' demand for loans in the second quarter was the lowest since its records began two decades ago. That's not surprising considering that benchmark interest rates are at their highest level since 2000, while banks are charging companies and households the most for loans since 2008 and 2012, respectively.

These grim economic indicators suggest the bitter medicine dispensed by Lagarde and her colleagues is working. Euro zone inflation has halved from the 10.6% peak it reached in October 2022. However, prices are still rising at more than twice the ECB's 2% target and the central bank expects them to remain above that level until at least 2025. Policymakers in Frankfurt have hinted that, even if rates stop rising soon, they will remain elevated for a while. That will put more downward pressure on the economy.

To be sure, neither the ECB nor professional forecasters in the financial services sector expect a recession this year. The central bank has pencilled in GDP growth of 0.9% in 2023 while economists polled by Reuters, on average, reckon the bloc's output will expand by 0.5%.

One bright spot is the region's workers. The euro zone's unemployment rate is at an historic low of 6.4%, largely because companies embarked on a hiring spree to meet the spike in demand for goods and services after Covid-19. And they are not done yet. Around 3% of available jobs in the bloc are currently vacant, close to the 3.2% record reached in the second quarter of 2022. At the current pace, it will take until 2026 for the vacancy rate to return to its pre-Covid level, reckons Capital Economics. Europe Faces Dirtier Inflation Fight than U.S._2

Europe Faces Dirtier Inflation Fight than U.S._2

Though a recession would lead to increased layoffs, the resilient job market suggests a short and shallow downturn could avoid mass unemployment. European labour regulations and strong unions, which make it harder for companies to fire people in a recession, would also limit the damage.

That in turn could allow the ECB to enjoy some version of the "immaculate disinflation" playing out in the United States. The problem for Lagarde, however, is that workers' increased bargaining power is feeding through into higher pay. Labour costs in the euro zone rose 5.0% in the first quarter of the year compared to the same period in 2022. That's hardly compatible with bringing inflation back down to 2%. Europe faces a longer and dirtier fight to tame rising prices.

Source: Reuters

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Owen Li

Commodity

Energy – Saudi extends cuts

The oil market moved higher yesterday, with ICE Brent settling above US$90/bbl for the first time since November. Saudi and Russian supply cuts were the catalyst for the move higher.

Saudi Arabia announced that it would extend its voluntary supply cut of 1MMbbls/d until the end of the year. Similarly, Russia said that it would extend its export cut of 300Mbbls/d through to year-end. While it was largely expected that these voluntary cuts would be extended, expectations were for a one-month extension rather than three months. This does leave the market with a deeper than expected deficit over the fourth quarter of 2023, which should continue to support prices. For now, we are reluctant to revise higher our price forecasts on the back of this extension, as demand concerns continue to linger and Iranian supply is rising. Iran is producing close to 3.1MMbbls/d and plans to pump around 3.4MMbbls/d. Meanwhile, our oil balance shows a small surplus in the first quarter of 2024, which should limit prices moving significantly higher. We continue to forecast that Brent will average US$92/bbl over the fourth quarter of this year.

Looking further ahead, we would not rule out a further extension of these cuts (fully or partially) into early next year, given that our balance sheet shows that the oil market will be in a small surplus over the first quarter of next year. Any cuts will obviously depend on where oil is trading towards the end of the year and whether demand worries are still present.

Agriculture – US weekly grain inspections decline

The latest crop progress report from the USDA shows that 53% of the US corn crop is rated in good to excellent condition, which is down from 56% the previous week and slightly below the 54% seen at the same stage last year. The soybean crop also deteriorated over the week, with 53% of the crop rated good to excellent, down from 58% the previous week and also below 57% seen last year. Meanwhile, the spring wheat harvest continues to progress well with the harvest 74% complete, up from 54% the previous week and above the 68% harvested by the same stage last year.

The USDA's weekly export inspection data for the week ending 31 August showed weaker export demand for corn and wheat. Export inspections for corn stood at 481.3kt over the week, lower than 600kt in the previous week and 543kt reported a year ago. Similarly, US wheat export inspections stood at 300kt, down from 390.4kt a week ago and also lower than the 538.5kt seen last year. For soybeans, US export inspections came in at 378.6kt, compared to 326.1kt from a week ago and 500.3kt reported a year ago.

In Australia, the government has trimmed its wheat production estimates by 3% from June to 25.4mt, which would be 36% smaller than the record harvest seen last year. The revisions were made primarily due to dry weather conditions and below-average rainfall in some wheat-growing regions.