Sasfin : Forex Daily Market - Oil prices are down for a second straight session

Today's Talking Point

Oil Update

Analysis: Oil prices are down for a second straight session this morning, extending yesterday's declines which were sparked by weak US economic data and another chunky build in US inventories. Brent crude touched highs of $87.85 per barrel yesterday but declined in the US session back below $85 following the economic and inventory data releases. The European benchmark is trading just below $84 per barrel this morning and is testing its 50DMA support level as economic growth concerns persist and pressure the market. These losses could be extended today should the official EIA data corroborate the build in US stockpiles, while there is limited data scheduled for release that could assuage fears of a major economic slowdown in the US or Europe. Meanwhile, time spreads show a mixed picture currently. Brent's prompt timespread is still in contango, maintaining its bearish structure. However, spreads further out the curve looks quite bullish. This suggests that the near-term pressure in the market is expected to give way, and oil prices will rally later in the year. However, this depends on the scale of the coming economic slowdown, which we expect may be deeper than most are forecasting.

Rand Update

The spotlight was squarely on economic data yesterday. On the local front, investors had December CPI numbers to digest, which showed that consumer inflation continued to slow into the end of last year. Specifically, CPI growth decelerated from 7.4% y/y to 7.3% y/y, even though it accelerated from 0.3% to 0.4% in month-on-month terms.

Due to the SARB's aggressive rate hikes last year and SA's structural economic headwinds, the inflationary cycle has well and truly turned. The SARB will, however, continue to hike interest rates through the months ahead to bring inflation back into its 3%-6% target range, but relatively smaller increments are to be expected.

Perhaps more interesting for global markets yesterday were US economic releases, which added to signs of softening demand and subsiding inflation there. US retail sales fell by the most in a year in December, industrial output contracted by the most in 15 months, and producer prices tumbled.

It is clear that economic weakness in the US is starting to become more widespread, pointing to disinflationary pressures in the pipeline that will allow the US Federal Reserve to slow its rate-hike cycle and, perhaps, pivot to looser monetary policy as soon as this year. In turn, this would ease pressure on the SARB to maintain high interest rates, and allow it to also pivot to rate cuts later this year.

The ZAR is facing strong crosscurrents at the moment as it navigates rising global recession risk reflected in weak US economic data, as well as moderating interest-rate pressure amid bets that economic weakness will force the Fed (and other central banks) into implementing more supportive monetary policy. So while US Treasury yields are sliding, the USD continues to enjoy a degree of support that is preventing a further correction towards fair value, for now. Accordingly, the ZAR is struggling for directional impetus, but continues to drift towards slightly weaker levels just north of the R17.0000/$ handle. Techs suggest the ZAR bears are losing some momentum, however, potentially signalling a turnaround in fortunes lies ahead in the coming sessions.

Bond Update

Bonds/Yield Curve: Weaker than expected retail sales in the US raised the probability of a slowdown and recession. Furthermore, the housing market is coming under increasing pressure, while Wall St is starting to price in weaker demand. The guidance coming from corporates is more defensive as companies try to protect their profitability and job losses loom. While the Fed may talk about tightening further to reign in inflation, the market does not believe it.

US Treasury yields have moderated significantly and eased the pressure on the local bond market in the process. Expectations are that yield curves abroad and domestically will shift lower and that the shape of the curves will stabilise to signal the turn in the business cycle. For now, the defensive play will be to stock up on more bonds, which could well outperform equities through the quarters ahead.

FRAs: A sharp drop in US Treasury yields confirms a turn in the business cycle. The Fed might hike rates in the US a little further, but the top is near. The same applies to SA and beyond next week's MPC meeting, where the SARB will likely hike, and the window for further tightening is rapidly closing. The FRA curve turned received yesterday, and rates nudged a little lower. The 12X15 vs 1X4 spread widened back to -21bp, signalling an increasing chance of rate cuts towards the end of the year and the beginning of next. Much will depend on whether the ZAR can continue to appreciate and whether inflation surprises more regularly to the downside in the months ahead.

Repo: The SARB has thus far kept in lockstep with the Fed to ensure that negative speculation against the ZAR is discouraged. They have been successful in that, and their conservative stance on monetary policy means that the monetary space for inflation to take hold no longer exists. There may be one more 25bp hike at the first meeting of 2023, but after that, the SARB may signal that they have done enough

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