FX, Bond Yields and Oil Prices
Oil gains 40% from its February lows, trading at $47.47, and $1.00 below its 100-day moving average, a trend that hasn't been broken since August 2008. The simultaneous advance in US bond yields along with oil prices may appear unusual given the erosion in global economic growth. But it is all about supply as increasing supply of US borrowing (another weekly batch of +$60 billion in US Treasury auctions) and mobilized stocks of US crude oil constitute the main forces behind the ensuing price dynamics in Treasuries and WTI. WTI eyes $51.00 as the next key target, while 10-year yields have yet to breach the 3.05% level.
While the notion of rising US bond yields and a falling dollar may sound counter intuitive to those who firmly believe in the direct yield-FX relation, such is not the case when bond yields are driven up by increased borrowing rather than increased growth/inflation expectations. In the case of crude oil, the WTI benchmark has now resumed its more normal pricing of reclaiming its premium above London Brent, after being priced at a discount since November. Sundays upcoming OPEC meeting may be a decent excuse for rising oil prices, but the escalating supply builds at the Cushing hub have finally triggered orders from refineries at prices not seen since 2003.
The implications of rising oil prices and US bond yields are USD-negative, especially if the ensuing bear market bounce in global equities extends ahead. As this takes place, markets start using the growth argument to rationalize the rise in oil prices and bond yields, which would only accelerate USDs sell-off against non-JPY currencies. A temporary return to risk appetite defined as no more than 25% rally in equities (see charts below) could subject the USD to particularly hefty losses against AUD (0.68), EUR (1.31) and NOK (6.60).
Finally, jump in risk appetite comes as no surprise to a market standing at 16-17 yr lows in the major US indices, lacking major US economic data and providing bottom pickers to mount what may be the first real signs of a bear-market raly since January. While pundits are discussing the importance of closing above 700 in the S&P, the next major resistance stands at 775, followed by 805 until we're likely to see renewed downside. As signalled in today's morning IMT, Aussie and Nokkie respond best to today's rally (see AUDCHF in today's HotChart), while GBPUSD sends a negative signal by failing to close above $1.3850 in London trade. Such a failure in NY close would cast prolonged negative dynamics on GBP.
While last week's feature article highlighted the deteriorating fundamentals in the Canadian dollar, todays piece reiterates the case for the Australian dollar, which appears set to exploit any advances in risk appetite as the currency is characterised with superior structural foundation (lowest external deficit in 7 years, lowest budget deficit in G10. Readers of my HotChart section have seen an array of calls favouring AUDCHF, AUDJPY and AUDCAD. The Aussies strength was also manifested in the currencys out-performance of the CAD, NZD and GBP during bouts of risk aversion (falling stocks).