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Daily Fix: Middle East tensions promote huge moves in crude

Chris Weston
Head of Research
15 Sept 2019
We start the week with oil front of mind. And our first take on how traders saw this was in the petrocurrencies, with traders expressing this view with good buying in NOK and, to a lesser extent, CAD. We should also see buying in the RUB as the day rolls on. The moves in both Brent and WTI have been staggering, with Brent crude up nearly 20% at one stage on the open, although price has settled back a touch as US President Donald Trump has ordered the release of reserves.

Aside from good selling in TRY (Turkish lira) and ZAR, this obviously isn’t a good day if you’re an oil importer, although we aren’t seeing too much of a move in the CNH. Gold has found a better bid and looks compelling in this environment, sitting at USD $1,511. We usually assimilate higher crude moves with higher equity and broad support to risk, but obviously the reasoning behind the move alters that way of thinking. The fact S&P 500 and NASDAQ futures are 0.7% and 1.1%, respectively, tells a story of a weaker open to Asia, but it isn’t so much an index play today. And clearly, we think in terms of crude thematics — energy names are going to find a strong bid, as will defence names and any stock sensitive to higher oil, such as airlines, will find a strong drawdown on the open.

XTIUSD daily

I’ll be keenly watching inflation expectations in the fixed-income world, especially in Europe, where EU 5y5y inflation swaps hold a meaningful correlation coefficient with Brent prices. There are still too many questions for oil traders in the short term that may not get answers straight off the bat.

Questions on investors minds

This isn’t just a question of who or even what actually caused the attacks, and whether this goes further than just to the Iran-backed Houthi rebels. The obvious questions some have raised are whether we’ll see further attacks given how vulnerable Saudi infrastructure is, and does this attack frame the start of something more sinister in the region.

In a world that saw signs last week that perhaps sanctions could be lifted on Iran, that argument now feels some way off. And the recently sacked John Bolton would clearly be shaking his head. Depending on how long this goes on for and how long it takes to get production fully back on, oil traders will be watching Saudi inventories, which could track to multiyear lows while trading the ever-ballooning Brent-WTI spread.

USDJPY is tracking -0.5% at 107.59, although buyers have come in post-Trump comments. Moves in USDJPY and S&P 500 futures are interesting, as it suggests we’ll see buying in US Treasury futures in early trade. After last week’s wild scenes and sizeable unwind of an extended US Treasury long exposure, today’s tape could give us a solid insight into whether traders will use the early strength to offload further positioning or whether this is the time to gingerly wade back in. Clearly, tensions in the Middle East is new news and one that has to play out.

USDJPY tracking US Treasurys

Considering USDJPY managed a 1.1% rally on the week, so buyers may support this weakness. But this was a function of the fixed-income market having quite the move, and a 34bp move higher in yield for US tens isn’t something you’ll see too often. For the stats heads out there, this was a 3.5 sigma move and the fastest rate of change (ROC) since November 2016.

If we use tens as our benchmark, we can see yields testing the two standard deviation of the line of best fit (at 1.94%) of the bull trend drawn from the November high. So, if the Saudi oil story doesn’t manifest into a more protracted risk-off theme, then we could see a further move into 1.94%. That also marries nicely with the July lows, so it’s meaningful, especially with a stochastic momentum crossover on the weekly. I was looking to fade rallies into 108.75/109, so this also fits should we see bond sellers come back in today.

We can also see huge moves in the US rates market, with January fed funds future (yield) gaining 13bp, highlighting a market that still sees one more cut from the Fed after this week’s likely 25bp move. But that setting has been wildly altered. Aside from the incredibly overbought and overloved positioning in bonds, the news flow has warranted the repositioning, and it’s spilled over into other trading factors — that being a strong unwind of short copper/long gold, low volatility/high beta, and Russell 2000/S&P 500.

The better feel toward US-China trade has resonated, with some excitement about an interim trade resolution and China exempting some US ag products from the 25% list. Is this enough to see the Federal Reserve hold off this week? I’m unsure. Even after the move in rates, the probability of a cut this week is in 96.9%. We can add in good economic data while in Europe there’s much division within the ECB’s ranks on how aggressive policy should be. If we look at the European rates complex (here I look at EONIA 1y1y forwards), we can see one-year forward expectations fell from -73bp to -57bp on the week.

That’s supportive of the EUR. But on the daily chart EURUSD has no idea what to think of this dynamic, with sellers happy to fade moves into 1.11. On the one hand, you see the ECB loathe to cut rates any further; however, keeping a lid on EUR buying, you have a bank committed to buying assets for an uncapped period. We should see this battle resolve itself one way or the other this week.

GBP in a sweet spot

GBP was the superstar in G10 last week, with GBPJPY gaining 1.8% and thereby increasing hope we see a deal before 31 October. GBPUSD two-month implied volatility collapsed from 16.12% to 8.93% in recent times, showing a certain calm has returned. But on Friday we’re seeing GBP volatility buyers emerge ahead of a meeting between British Prime Minister Boris Johnson and his EU comrades Jean-Claude Juncker and Michel Barnier. That’s one to watch as GBP shorts have covered, and the risk of a deal under Johnson is seemingly growing.

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