As we mentioned in our post on Monday, the fluid situation in the disputed oil province of Kirkuk and how a disruption the 600,000 barrels a day of crude production coupled with the technical setup in Brent crude oil could lead to $2-3 higher in price.
Aljazeera is reporting that the escalation is largely over and Iraq has achieved its objectives.
Despite the positive developments in Iraq/Kirkuk that should lower the risk premium, Brent crude oil is trading at the highs of this week.
If prices hold throughout the day as the risk premium is reduced further, that is bullish and means there is more to the underlying bid-tone than this one single event that many focused on last weekend. One positive offset is the news that Iran and other OPEC countries will support an extension of production cuts at current levels through the end of next year.
The other catalyst we highlighted was the large shut-in production regarding US hurricanes. The view was that this week’s storage reports should bode well for oil prices and sentiment, or on the margin, keep deterring short sellers.
Last night’s bullish API report is evidence of that, which had the second largest crude draw of the year. We expect a similar outcome when today’s DOE report is released.
For those not following closely, “thousands of Iraqi soldiers and allied militia are locked in an armed standoff with Kurdish forces in the disputed oil province of Kirkuk amid a sharp row between Baghdad and the autonomous Kurdish region of Iraq.” (Source: Aljazeera)
The situation is fluid, including perceived deadlines by Iraq for Kurdish forces to stand down.
Regarding, oil supply, it is being reported by various sources that the 600,000 barrels a day of crude production from Kirkuk’s oil fields and deposits inside the adjacent Kurdish region continued as usual.
So, with a heightened threat of intermittent disruptions to oil supplies, the question becomes how much does crude oil go up in price following any halt to exports caused by fighting?
Most investors dedicated to the energy markets that we speak to believe that the barrel would initially jump $2-3. From there, conventional wisdom suggests the barrel would move incrementally higher the longer an armed conflict would last, or the more out of control it becomes.
Using 600k/bpd as a benchmark, $2-3 seems reasonable to us. However, we would note that a $2-3 move higher in the barrel would have significant bullish implications technically.
For example, to the right is a long-term reverse Head & Shoulders formation and ascending triangle using the continuous Brent crude oil contract (CO1), two key patterns in classical charting.
At the time of this writing, the onshore Chinese yuan was last trading at 6.5792 against the U.S. dollar (USD/CNY), compared with the official closing price of 6.6285 on Monday. The People’s Bank of China (PBOC) set the yuan central parity rate at 6.6273, 0.33% stronger than Monday's 6.6493.
Put another way, upon returning from a week’s long holiday and ahead of the Communist Party Congress in China in mid-October and US President Donald Trump’s visit shortly after that, currency traders declared that the yuan will strengthen.
Here are the reasons why that declaration was made:
Collectively, professionals are re-open to a downside target in USD/CNH of 6.50, over the next month.
Next, the euro exchange rate is trading like the correction that began in early September has run its course.
Firstly, on a relative basis, the eurozone manufacturing PMI showed more expansion than the US after two-months the other way around.
Secondly, we are now one week closer to the next European Central Bank (ECB) meeting on October 26th, or the potential announcement of the removal of extraordinary monetary policy.
Given the market is fully priced for two interest rate hikes in the US between now and next June, interest rate differentials suggest that Europe has plenty of scopes to catch up with tighter monetary policy expectations.
Thirdly, looking at the soft and hard data for Germany going back to September 10th, there is little question that the soft data, or extremely elevated positive sentiment, has fed through to the hard data.
Put another way, ECB President, Mario Draghi, is letting Europe “run hot.”
After accounting for China’s absence during the week-long holiday, the juncture ahead of the ECB meeting, just like that, the broad US dollar index failed where the top of the intermediate-term trend channel coincides with the 100-day moving average and is poking its head back in.
In response to what we sketched out above and the bid-tone in crude oil, MSCI Emerging Markets (EM) Index Futures are +0.55%, or trading as if its business as usual.
The US dollar is weaker relative to all G10 and all emerging market currencies that are not closed for a holiday.
Maybe it is because US small caps (symbol: IWM) showed their first day yesterday of working off the record overbought conditions (i.e. 9-day RSI was 95) on the Trump-value escape velocity trade?
Maybe it is because the US regional banks (symbol: KRE) broke their 12-day record winning streak yesterday after the probabilities for a December interest rate hike rose to 75% and March 50%, the maximum upside?
Maybe it is because the euro exchange rate has stopped going down? After all, European automakers (SXAP) have been the best performer in the German DAX over the last month. In fact, their 9-day RSI is now above 90 for 13 consecutive days and the highest levels in history.
Maybe it is because the broad US dollar (symbol: BBDXY Index) reached the top of the intermediate-term downtrend channel and completed a “doji” exhaustion bar yesterday?
Maybe it is because the iShares China Large-Cap ETF (symbol: FXI) recaptured its high price after China cut its Reserve Requirement Ratio (RRR) for banks and unleashed $500 billion in liquidity before its week-long holiday?
Maybe it is because every single manufacturing measure in the world is in growth territory (see Top Observations section) and that is more bullish for international and emerging markets than the US on a relative interest rate differential basis given the Fed has already hiked 4 times and is now priced to hike 3 more times and reach a 2% policy rate by the end of next year?
Maybe it is because Minnesota Fed President Neel Kashkari, the most dovish of all birds, and is not an economist, is the dark horse for the Fed Chair?
Maybe it is because the Reserve Bank of India (RBI) held interest rates steady after the bond market had developed some rate-cut expectations over the last few days. Hence, the first reaction is negative. After all, the Dollar-Rupee (USD/INR) is showing the largest negative risk-adjusted return in currencies. Given the largest and most rational investors in the world control the money flow in this emerging market stronghold, and India was the most badly impaired in this little EM wobble over the last two weeks, perhaps it is a sign that India bounced back the most first?
Maybe it is because NEC Chair, Gary Cohn, and the Secretary of Treasury, Steven Mnuchin, put on the worst sales display in history selling the tax plan starting last Sunday morning on the usual talk shows? Now the market needs clarification, or more details considering that inflation metrics already price at least 80% of where they were at last November to January knowing that this tax plan will be watered-down incrementally.
Maybe it is because Friday’s payroll headline numbers will be called low due to Hurricane effects, and some paid forecasters see scope for a negative number? Or worse, what if the wage component is lower after the weak PCE inflation data last week?
We will let you decide.
For us, at the risk of sounding cavalier, there is a high probability that the US dollar counter-trend bounce is over and the broader market trends reinsert themselves.
Let’s see what happens next.
The US dollar is broadly better bid. The three most cited reasons are:
The question is what are you supposed to do with that information? This is where having an investment process is important.
The unconditional probability of a hike at the March FOMC meeting traded above 45% this morning.
This same thought process should be applied to US dollar strategies, interest rate sensitive equities (i.e. Financial sector), or correlated strategies to the US yield curve (i.e. Japanese yen/Nikkei-225 Index).
The takeaway is that if you are entering these trades now, you are doing so at the extremes and at a poor location.
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