Doha Failure Sets Tone

Oil producers failed to reach an agreement yesterday at the meeting in Doha.  That is the main spur to today's activity.  It is not that the outcome was a surprise.  One newswire poll found around half of the respondents thought an agreement was elusive.  

Although not oil experts by any stretch, we too thought political considerations made it unlikely that Saudi Arabia would be willing to sacrifice market share to its rival Iran.  We also understood why Iran could not accept a freeze on its output after sacrificing to some extent it nuclear development in exchange for its oil sales. 

In the foreign exchange market, the Canadian dollar, the Norwegian krone, the Malaysian ringgit, the Russian ruble and the Mexican peso are particularly sensitive to the drop in oil prices.  The Australian dollar is also under pressure, partly through the commodity channel and partly as a result of domestic politics, where the failure of the Senate to support legislation by the Prime Minister boosts the odds of a full election (both chamber of parliament).  

An Australian election could be held in early July. In the larger context, for US Federal Reserve, which has appeared to raise the saliency of international variables in its policymaking equation, a number of political events around the time of its June meeting may pose a fresh challenge.  Consider that in addition to the UK referendum, there may very well be a Spanish election and now an Australian election.  

A key stumbling block for an agreement among oil producers was the Saudi demand that Iran participates in a freeze of output.  Iranian output is slowly recovering.  The operative word is slowly.  Although Iranian officials had played up the speed by which its output would pick-up, it has not materialized.  This means that the next OPEC meeting, in June, will also be too soon for the Iranian participation.  It now looks like an agreement will only be possible later this year, if not next year.  

The June 2016 light sweet oil futures contract closed before the weekend, under pressure, at $41.71, and open earlier today near $39.90.  It fell to $39.00 before recovering, moving into the gap in the European morning, reaching around $40.20.   Brent was followed a similar pattern; gapping lower, selling off, and then recovering in the European session.  

The dramatic drop in the price of oil weighed on equity markets.  It snapped the eight-session advancing streak in the MSCI Asia-Pacific index,  which fell nearly 1.5% from the pre-weekend four-month high.  European shares are also under pressure.  The Dow Jones Stoxx 600 is off around a 0.3% near midday in London.  While the losses are led by the energy sector, nearly all industry sectors are lower, save consumer discretionary.  

Benchmark 10-year bond markets are little changed.  Of note Portuguese bonds, which have been underperformed recently, have begun playing catch-up.  The 10-year yield fell 18 bp last week and is off another eight bp today.   We remain concerned that DBRS may remove Portugal's investment grade status at the end of the month in its review.  If so, it would join the other three main rating agencies in seeing Portugal's credit below investment grade, and this would prevent the country's bonds from being included in the ECB's asset purchase program.  

The ECB meets later this week.  It is unreasonable to expect any new initiatives after last month's significant measures.  Investors are looking for details about the corporate bond purchase program with will begin at the end of the quarter.  Given various considerations, like size and liquidity, many economists see scope for a modest corporate bond purchase program that may be around 10 bln euros a month.  Those countries with deeper bond markets, like France and Italy, for example, are thought to be in a favorable position to benefit from the program.  

The US dollar rose 0.6% against the yen last week but is giving that back today.  The greenback's low at the start of last week was just below JPY107.65.  It recovered to almost JPY109.75 before the weekend but reversed lower in the North American session.  The dollar gapped lower at the start of today's session and fell to nearly JPY107.75 before finding a bid.  It made it back toward the session high near JPY108.50 in the European morning.  The pre-weekend low was set near JPY108.60.  

The weakness of global equities, including a sharp 3.4% loss of the Nikkei, took a toll.  In addition, report over the weekend played up the lack of G20 support for Japanese intervention.  This, like the outcome of the Doha meeting, is not major surprise.  It had seemed clear to us that neither the US nor Europe would be particularly sympathetic to Japan's plight.   

We argue that the "arms control" agreement that seeks to avoid currency wars remains largely intact.  If a country comes to close to violating the agreement they are called out.  This arms control agreement recognizes a difference between pursuing monetary policy, using conventional and unconventional tools to stimulate economic activity or fight deflation that results in a weaker currency, and adopting a beggar-thy-neighbor currency devaluation policy to bolster competitiveness. 

The press reports suggesting the isolation of some Japanese officials who want to intervene may have spurred some yen buying regardless of what happened in Doha.  For today, we would place emphasis on the JPY108.50-60 area, with a move in North America above there, lending credence to out idea that the dollar is carving out a bottom against the yen, and today's price action may count as a retest.    

The euro is consolidating last week's losses.  The $1.1320 area marks the initial retracement objective.  If the euro has begun its own topping pattern, then the $1.1350-$1.1380 area is important.  

The US economic calendar is fairly light this week, with new and existing home sales the main feature.  US companies are still in the middle of earnings season.  Today, three regional Fed Presidents speak (Dudley, Kashkari, and Rosengren).  We put emphasis on Dudley, but Yellen has made it clear that the FOMC meeting next week will not result in a policy change.   

The impeachment process of Brazil's president took a major step forward yesterday.  However, given that some 150 members of the lower chamber are under corruption investigations themselves, including the speaker and the vice president, who is Rousseff's like successor, we caution against thinking that pushing the PT out is a panacea for its serious economic, political and social challenges.  

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