Market Talk

From the FXWW Chatroom: The OPEC agreement reducing output to 32.5-33m barrels a day, suggesting a production cut of 240-740k b/d, has sent oil prices 6% higher. and our call seeing NOK, RUB and COP breaking higher is bearing fruit, but there are also implications for other currencies to draw, with the impact of higher oil prices on yield curves working as the catalyst. First, higher oil prices helps our call projecting a weaker JPY, second it boosts European currencies relative to JPY and USD and third it boosts the EM high yield trade for now, but plants the seed for USD breaking higher later this year and into 2017.
EM rally: However, markets work in steps. Rising oil prices may develop spillover effects into other commodity markets, which would help commodity-exporting EM countries. Hence the high yield EM rally should continue for now. Working in the same direction is that it has been petro-dollar-related inflows boosting currency reserves in EM economies from 2009-12. Some market participants may assume that yesterday’s OPEC agreement may lay the foundation for a repeat of what happened seven years ago. Here we disagree. Many oil-producing countries struggle with twin or at least fiscal deficits, suggesting that this time petro-dollars may be urgently required domestically.
The USDJPY rally: Hence, the EM high yield rally may find its limitations later this year. Better US oil sector investment combined with a likelihood that some DM countries may have closed or are in the process of closing their output gaps should stabilise yield curves (via higher growth and inflation expectations), which should work in favour of USDJPY and EURJPY. Sure, USDJPY has not yet exceeded the 102.50 resistance, which would confirm that a bottom has been traded, but higher oil prices have at least increased the probability of USDJPY breaking higher from here. Remember, our previous call for JPY strength (laid out in November) was based on intensifying global deflationary pressures, China allowing CNY to fall and Japan’s ‘exhausted’ yield curve reducing the BoJ’s flexibility to react to JPY strength. Now it seems global deflationary pressures may be easing, the CNY-TWI is stabilising and the BoJ’s new monetary policy is turning it into a yield curve manager.
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