Drone attack a major setback in the middle-east; The market pares Fed cut bets


Oil spikes as Saudi Arabia’s production gets disrupted. Fed cut bets are being pared.
Philip Wee, Eugene Leow16 Sep 2019
    Photo credit: AFP Photo


    FX: Oil spikes

    Brent crude oil prices spiked to a high of USD72/barrel this morning from last Friday’s close of USD60 on news that drone attacks (allegedly supported by Iran) have halved oil production in Saudi Arabia. Prices subsequently retreated to around USD68 on reassurances from Saudi officials that a third of the lost 5.7 million barrels will be restored today, but full resumption is estimated to take weeks. US President Donald Trump has authorized the release of oil from the US Strategic Petroleum Reserve which currently holds 645mn barrels.

    Guarding against complacency, this could be the calm before storm. The White House has not ruled out a Trump-Iran meeting or a US military response. US Senator Lindsey Graham has urged an attack on Iranian oil refineries. Iran has denied any role that it supported Houthi rebels in the attacks on the Saudi facilities. The situation remains fluid and volatile.

    Emerging Asian currencies most at risk to higher oil prices belong to countries with the largest oil trade deficits. They are the South Korean won, the Thai baht and the Indian rupee. The Malaysian ringgit will be the most resilient; Malaysia is the only net oil exporter in EM Asia. The region is vulnerable to prolonged high prices weighing on the global economy. Recent hopes for an easing in China-US trade tensions could be displaced by the fears of an escalation in US-Iranian tensions leading to conflict. China is not only Iran’s top trading partner but has also extended USD10bn in loans to Chinese companies to build infrastructure in the country.

    Rates: The market pares back Fed cut bets            

    The market has been steadily dialing back Fed cut expectations and duration risks over the past two weeks. Initially, higher USD rates were driven by growing recognition that the rally in US Treasuries may have overdone. More recently, the counter-intuitive reaction (German Bunds sold off) to the European Central Bank (ECB’s) announcement of open-ended asset purchases and the possibility of an interim China-US trade deal led to more duration jitters. In short, the DM space may have already more than priced in any easing that is likely to take place and are caught wrong footed when the trade war narrative turned modestly better.


     
    While market participants are convinced that the Fed will cut this week, wavering resolve for further aggressive easing can be seen in the longer-dated Fed funds futures. In early September, the market was looking at a Fed funds rate of below 1%, this figure has since shifted above 1.30%, a removal of about 2 cuts. Longer-term rates have also pared back excessive pessimism with 10Y US yields (1.90%) some 45bps above the recent low. Fed guidance will be closely watched, although this will quickly be overridden by trade war or geopolitical developments. We reiterate our view that 10Y yields will be in the 1.50-2.0% range in the short term. While longer-term DM rates have likely traced a bottom, lingering risks on Iran, trade war and still-weak global economic numbers will likely restrain upside in yields.  

    Philip Wee

    FX Strategist - G3 & Asia
    philipwee@dbs.com

    Eugene Leow

    Rates Strategist - G3 & Asia
    eugeneleow@dbs.com

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