Sasfin : Forex Daily Market - Oil is heading for a third straight weekly gain

Today's Talking Point

Oil Update

Analysis: Oil is heading for a third straight weekly gain despite the fact that risk assets have had a turbulent time this week. Brent surged yesterday to over $82 per barrel as supply constraints among some key OPEC members have seen the market tighten. Libyan production remains crimped by ongoing civil unrest, while Kazakhstan's largest oil producer has had to alter output at its Tengiz field following protests in the country. As a result, it is looking very unlikely that OPEC+ will meet its goal of increasing output by 400k barrels a day through January, with the outlook for February not too much brighter in terms of production levels. Demand for prompt barrels of oil has also been rising, which has seen the spread for the nearest dated contracts rise to around 75cents per barrel currently. This is its highest since mid-November, just before the Omicron scare roiled markets, and suggests that we could see prices rise back towards $85 per barrel in the near term.

Rand Update

The ZAR recovered from its post-Fed minutes decline yesterday, defying a trend of broader EM weakness as it drifted back towards the base of its recent trading range. From point to point, this amounted to around 2% of intraday gains, with the size of this move, despite a lack of a strong catalyst, reflecting just how thin liquidity conditions currently are in the market. The move was primarily due to USD selling by exporters and other corporates paid in dollars, while professional traders generally also appear uncomfortable with the ZAR's undervaluation against the USD at levels close to R16.0000/$. Lest we forget, the ZAR was trading sub-R13.5000 not too long ago back in June.

Note that the local data card picks up today with the December edition of the Absa manufacturing PMI. Consensus expectations as per Bloomberg surveys are for the factory-sentiment gauge to decline but remain well above the 50-point threshold that separates contraction from expansion in the sector. The numbers will be compared with the Standard Bank all-economy PMI for the same month that was released on Wednesday and pointed to a broader decline in business conditions and a downturn in economic activity in SA. There is thus a risk that the manufacturing PMI disappoints today, especially given Omicron fears and related travel restrictions, and supply-chain issues that were prevalent into the end of last year.

However, the bulk of the market's focus will be with the December US employment report today, which is expected to reflect a general improvement in US labour market conditions. According to consensus expectations as per Bloomberg surveys, nonfarm payrolls should increase at a moderate pace, while it is also likely that the November figure will be revised higher. The unemployment rate is expected to decline, even as the labour force participation rate grows.

Bond Update

SA's FRA market has taken on a distinct payer bias following the hawkish Fed policy minutes, as investors price in a lower level of USD liquidity. The payer bias will also be supported by the logic that tighter Fed policy implies a higher risk that local rates will need to rise to prevent ZAR depreciation and, by extension, raising risks of an acceleration in inflation pressure in SA.

At the same time, rates, as they stand, are also classified as "highly stimulatory" given that the neutral rate according to the SARB Quarterly Projection Model assumptions is 2.3% above inflation in 2022 and 2023, and 2.4% in 2024. This suggests that the repo rate will need to rise from 3.75% to roughly 6.5-7% given expectations for CPI. The QPM assumptions have CPI averaging 4.3% in 2022, 4.6% in 2023 and 4.5% in 2024. Therefore, around 275-300bp worth of rate hikes could be seen if the SARB wishes to return the monetary system to a non-stimulatory setting. However, Governor Kganyago has stressed multiple times that the QPM is just one input into the SARB's decision process.

While ZAR risks are being priced in the FX derivatives markets, some countervailing factors could help the ZAR remain somewhat resilient even in the face of Fed tightening, which would lessen pressure on the SARB. These are well-reflected in the surplus trade account and very high real yields in the sovereign curve that raise ZAR attractiveness from a carry perspective. The inflation forecast also has downside risks if oil prices revert to a lower equilibrium level while low domestic growth persists. Persistently low levels of credit growth also reduce inflation potential from a monetary theory perspective. Rate hikes in such an environment could turn the screws on already low growth potential.

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