Sterling traders bewildered as turmoil over Brexit intensifies

How long can the OPEC+ buzz last?

Report prepared by Ahmed

Shibley

The Brexit agreement vote on December 11 is now looking unlikely according to talk from some senior Conservative members as the Irish backstop conundrum continues to dominate proceedings. The chair of the influential 1922 committee of Conservative backbenchers said yesterday that unless the UK had an answer to how it may remove itself from the Northern Irish backstop that he would ‘welcome the vote being deferred until such time as we can answer that question’. Prime Minister Theresa May, who is fully expected to lose the vote if it occurs, brushed aside such thoughts and said the vote would take place as planned. This is contrast to the television debate between the PM and the leader of the opposition which has now been cancelled as both the BBC and ITV have refused to host the debate due to the demands of either leader.

There has also been a growing groundswell from MPs to shift course from PM May’s deal to a softer Brexit with Parliament taking control of negotiations if/when the PM’s deal is voted down on Tuesday. As it stands, next week could be a make or break moment for Theresa May who may well not be the Prime Minister going into the New Year.

Against this chaotic background, Sterling has traded sideways with investors unwilling to commit themselves in such a volatile market. A softer Brexit would be met with some enthusiasm by the market and see Sterling push higher, while a lost vote and increased pressure on PM May to resign would leave the British Pound adrift and probing fresh 18-month lows. We are neutral on Sterling and will remain so until there is some Brexit clarity, and leadership, something that has been lacking over the last two years.

The ONE Thing: After little progress appeared on Thursday, OPEC emerged on Friday with an agreement to cut 1.2 million barrels per day by OPEC and strategic alliances. The market was shifting to expect a lower bpd cut, so the final number was welcome news, and crude rallied as a result.

Crude rallied 5% on the news release on Friday morning alongside another encourage US payroll report. WTI remains 11% lower YTD & 10% lower over the last 20-days. Brent is lower 6% YTD.

Crude returned to Contango indicating signs of oversupply. The new December 2019-2020 spread shows the market trades around Contango Traders work on the floor of the New York Stock Exchange (NYSE) on Dec 7 in New York City. The Dow Jones industrial average fell over 500 points on Friday as investors remain concerned about a possible trade war between

China and America. (AFP)

and backwardation. While OPEC may bring about a bounce, the damage appears to be done, and if anything, the actions from OPEC+ may simply allow a range to develop in the market.

Per BHI, US total rig count falls one rig to 1075 from 1076; US Oil rigs fall by ten to 877

A larger than expected production cut has given crude bulls all they wanted for Christmas, a reprieve of the massive selling. Crude jumped ~5% on larger-than-expected production cuts, which has had ripple effects to equity markets that were still open after the news broke of an agreed-upon 1.2m bpd cut after expectations were faltering that the previously expected cut would be reached.

The question now remains, how long can the OPEC+ buzz last?

Looking to fixed income, there is trouble brewing in the belly of the US Treasury curve, which indicates increased doubt about further growth (i.e., demand for oil) that could mean Friday’s reprieve lasts nowhere near as long as hoped.

The cut takes the current total production from OPEC from 33.13m bpd to ~32.33m bpd or ~2% of current production as of November 30.

Naturally, the supply side of the question being manipulated to support prices works best when demand remains the same or rises. Few are expecting that to be the case as evidenced by the inversion of the UST 2-5yield curve or the increasingly flattening UST 3m – 10yr yield curve, which measures the premium, albeit a shrinking premium of holding a 10yr UST against cash that now stands at ~49bps.

Naturally, you’re likely wondering how long the OPEC agreement to cut

production will have a positive effect on the market. It’s hard to tell. If perceived demand continues to fall, which will depend largely on emerging markets led by China who of course, is in the midst of a trade war with the US.

After news broke of the OPEC+ deal to cut 1.2m bpd (800k by OPEC & 400k by non-OPEC members,) the spread shifted back to backwardation thought the sustainability of backwardation, which is inherently crude positive remains in doubt due to the declining growth outlook.

As widely expected, the BOC decided to maintain their overnight policy rate target at 1.75 percent. In its press release immediately following the decision, Canada’s central bank struck a cautious tone over recent economic developments at home and globally. Key concerns cited cratering oil prices, muted business investment and slowing growth across major developed countries. Consequently, markets interpreted the comments as dovish and significantly reduced their expectations for future rate hikes. However, the steep drop in expectations could be an exaggerated knee-jerk reaction.

The implied probability of future rate hikes declined for most of November paralleling oil’s steep selloff over the period due to a worsening supply glut as fears of a deteriorating global economy mount. BOC noted that the country’s energy industry “will likely be materially weaker than expected.” In turn, this may evolve into a major headwind for the Canadian economy as well as the Canadian Dollar seeing that oil production accounts for $170 billion out of the country’s $1.8 trillion GDP – just shy of 10 percent of total economic output. While the BOC

stated that the Canadian economy expanded in line with projections for the third quarter, this could change over the final months of the year as economic data is suggesting positive momentum is fading.

On a more positive note, business investment should pick up with the recently signed US-Mexico-Canada (USMCA) agreement providing more clarity on trade between the countries. Also, employment numbers reported at the end of the week surprised to the upside. The Canadian unemployment rate dropped to 5.6 percent from 5.8 percent and the net change in employment crushed forecasts by adding over 94,000 jobs compared to the expected 10,000. Another development that could support a beaten down Loonie is the recent agreement by OPEC and its partners to cut oil production by 1.2 million barrels per day. Crude oil leapt nearly 6 percent on the news which also sent the Canadian Dollar higher.

The data dependent BOC will closely examine housing stats reported next week as it looks for signs of a sustained rebound across the sector. As for its American counterpart, the US market could come under pressure from highly anticipated data points that pose material downside event risk to the Greenback. With the US Dollar already starting to lose some of its luster due to weaker than expected economic developments and seemingly dovish remarks from the Federal Reserve, the USDCAD could see some downside in the short term due to the recent shift in sentiment.

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