Morning Commentary: Similar Doesn’t Mean the Same

Foreign Exchange - Morning Commentary
Similar Doesn’t Mean the Same
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Despite cooperation within OPEC+ to deliver historic production cuts, crude oil prices remain under pressure.  On the day, June WTI prices fell as much as ~21% as ETF funds and indexes reduced exposure to front end contracts, via unscheduled rolls, in order to avoid storage issues.  To the extent that a further reduction in supply is the only solution to balance the supply glut in light of the sharp drop in demand, petro-linked currencies should continue to face headwinds.  However, this group of countries is far from homogeneous, so what are some of the differences that would lead to outperformance/underperformance among petro-currencies?

Location on the cost curve: The current price war is being waged to force a recalibration of the global oil supply.  As such, high cost producers, such as the Canadian oil sands, are most likely to have long term implications. 

Energy export’s impact on a country’s balance of payments: Clearly, the bigger the impact that oil exports have on a country’s BoP, the bigger the impact that falling prices will have on a currency.  In this regard, the CAD and COP stand out for being two currencies that have large current account deficits despite being major oil exporters.  

Presence of a Sovereign Wealth Fund: Norway benefits from having a sovereign wealth fund that absorbs USD during normal times and that supplies USD during times of stress.  

Fiscal exposure: Clearly, the greater the linkage between oil revenues and the government’s fiscal position, the greater the impact from a fall in oil prices.  This sensitivity varies widely but is more prominent in EM. 

Storage Capacity:  The storage constraints in Oklahoma City have gotten a lot of press, but storage issues are pretty uniform around the world.  

From this framework, it would appear that the CAD is specifically vulnerable to the current oil selloff.  Conversely, the USD remains well positioned despite being one of the world’s top oil producers.  While shale production is one of the targets of the recent price war, oil receipts represents a relatively small part of a large and well diversified economy.  Moreover, the USD tends to strengthen during periods of market stress due to its anticyclical qualities.  
  • Markets continue to trade with a risk-on tone as virus data out of Europe and the US continues to trend lower and supports plans to tentatively re-open economies in these areas.  However, in Asia, second wave of infections are continuing to hit as illustrated by Singapore.  The high number of people that carry the virus without symptoms makes it very hard to contain transmission and raises the possibility that the virus returns in waves like the flu.  
  • The Fed begins the first day of its two day meeting today.  Yesterday, the Fed announced that it would expand its Municipal Liquidity Facility by lowering the population threshold for municipal borrowers eligible for the program.  Additionally, the end date of the program was extended to December 31. 
  • Sweden’s central bank kept rates and its QE program unchanged as expected.  The bank’s forecast envisions rates remaining at current levels until February 2021.  The SEK is stronger on the session as the statement and guidance was less dovish than expected, leading markets to price out some of its easing expectations.  
  • Japan’s jobless rate met expectations at 2.5% while the job to applicant ratio dropped to the lowest rate since September 2016.  With Japan imposing lockdowns, labor market data should get worse moving forward. 
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