Today's Talking Point Oil Update Analysis: Oil prices plunged yesterday and remain on the back foot this
Today’s Talking Point
Oil Update
Analysis: Oil prices plunged yesterday and remain on the back foot this morning as global markets have turned risk-off amid the prospects of further monetary policy tightening from major central banks. As a result, Brent has declined below $73.50 per barrel, while WTI has fallen below $69 per barrel, with both heading for their largest weekly losses since the first week of May. Yesterday’s losses also came despite the EIA data showing that crude stockpiles in the US fell and that fuel demand rose last week. Traders, therefore, are focused squarely on the macro environment, which is likely to remain a headwind for crude over the near term. The outlook for oil over the second half of the year still looks a little more positive. The market is expected to tighten further amid OPEC+ supply cuts, although China’s sluggish recovery has tempered these expectations to some degree. However, if we see central banks continue to hike rates and major economies experience hard landings, the oil market will struggle to gain any significant traction.
Rand Update
What started off as a consolidatory week for the ZAR has ended with the bears in full control of the market. Following a strong advance through mid-June, the ZAR was always looking ripe for some profit booking and a temporary correction. This is exactly what played out this week, with the catalyst being global monetary policy.
It has been evident across many jurisdictions this week that monetary policy remains the central driver of currency direction at the moment. Fed Chairman Powell’s hawkish testimony to the US Congress has helped the dollar recover from its recent lows. The Bank of England surprised markets with a 50bp rate hike after signs that UK inflation remains on the wrong path, providing pound Sterling with some support. And then there is the Central Bank of the Republic of Turkey (CBRT), which let the Turkish lira down by hiking rates by a less-than-expected 650bps yesterday, causing it to slide to new record lows.
All of this matters for the ZAR. The tightening of financial conditions in the developed world draws capital, that would otherwise have made its way to relatively higher-risk assets (such as the ZAR), away. As liquidity is pulled out of the global financial system, investors are turning more judicious over where they invest their capital, leading to broad-based risk aversion. SA is thus competing for a shrinking pool of capital. All the while, the Turkish lira’s rout also has a contagion effect on the rest of EMFX, with the ZAR, of course, a known bellwether for market sentiment towards EM currencies.
In all of these developments, the message is clear. Monetary policy matters, and the SARB may yet need to implement more rate hikes to prevent an inflation-fuelling selloff of the ZAR, even as inflationary pressures in SA ease. Notably, the market agrees, with forward-rate agreements (FRAs) currently pricing in a 25bp rate hike at the SARB’s policy meeting at the end of July.
The ZAR depreciated another 1% against the USD yesterday, and around 0.80% against both the GBP and EUR. It remains vulnerable to further losses into the weekend, with market sentiment still cautious this morning. Having said that, a sharp retracement of its recent rally appears unlikely, although a move towards the 50-session moving average around 18.7800 (for the USD-ZAR) is on the cards. Similarly, the EUR-ZAR market will also be targeting its 50-session moving average at 20.4200, while the GBP-ZAR market will have an eye on 23.7500, which lines up with the 38.2% Fibo retrace level of its recent decline
Bond Update
Bonds/Yield Curve: Interestingly, bonds did not blow out and follow the ZAR weaker. On the contrary, the bond market proved remarkably resilient, choosing to focus instead on the soft inflation data that was released earlier this week. It increased the probability that the inflation cycle had turned and the pressure on the SARB had eased. That is undoubtedly true, but persistent ZAR weakness may undermine those expectations.
Today’s ILB auction will be interesting. National Treasury will be auctioning off the I2031, I2046 and I2050. The longer-dated bonds will offer some insight into inflation expectations following the ZAR’s recent recovery and the softer-than-expected inflation data. Investors will need to weigh up the inflation data against the possibility that the ZAR could still experience more turbulence. For now, markets are trading calmly and not reacting immediately to the depreciation of the ZAR in the last two days, but that is because it appreciated so much in the week prior to that.
Whether the ZAR’s weakness is sustained will likely govern whether the bond market pauses for a while. A short-term spike and recovery will do very little. A sustained phase of ZAR weakness back above 19.00/dlr would likely do more damage, although there is evidence that investors are now looking through the cycle at a lower inflation and interest rate environment through the course of the next year.
FRAs: FRAs have consolidated their recent moderation, with rates consolidating at lower levels. While the short end has remained buoyant and positioned for another 25bp rate hike, the curve further moderated its expectations. While there is still a high probability of another two rate hikes of 25bp to come, the FRA curve has flattened considerably. The biggest movements happened at the long end of the curve, with the 9X12 vs 1X4 spread narrowing to just 11bp from around 35bp earlier in the week, while the 12X15 vs 1X4 spread has inverted to -1bp this morning from around 24bp on Wednesday. It is a substantial move that reflects the shift in expectations and a response to the recovery in the ZAR and the sharper-than-anticipated drop in inflation.
Repo: The SARB will likely hike again by at least 25bp at the next meeting and appease markets. Any expectations of rate cuts early in 2024 have been priced back out, and all eyes will be on whether the ZAR makes a full recovery or not. The ZAR is vulnerable, which may even prompt the SARB to remain hawkish, although the current recovery in the ZAR will go a long way to easing some of the SARB’s fears. The peak in interest rates priced into FRAs has now moved 50-60bp higher but could stabilise around current levels or moderate further if the ZAR’s gains are sustained.
Download Full Report
www.marketscreener.com