Sasfin : Forex Daily Market - oil prices fluctuated yesterday

Today's Talking Point

Oil Update:

Analysis: Oil prices fluctuated yesterday and are on the defensive this morning as demand concerns dominate traders' focus. Brent has dipped to around $85.65 per barrel, while WTI is trading near $80 per barrel when looking at the front-month contracts, with both benchmarks sliding after this morning's weak China PMI data. The official figures pointed to a further contraction in China's manufacturing sector for December, with weak demand signalled as the economy continues to struggle with rising infection rates after it rolled back most of its COVID-19 restrictions. Furthermore, comments from the head of the IMF regarding a global recession pressured commodity markets yesterday. With these demand concerns at the forefront, it is not surprising to see that the market is pricing in ample supply over the near term, with Brent and WTI prompt spreads trading in contango and widening out compared to levels seen a month ago. This increase in near-term supply is further highlighted by the increase in oil in floating storage. The amount of crude held in tankers around the world rose to 98.50mn barrels as of the end of 2022, up 11% compared to the previous week. With near-term supply concerns reduced and slowing demand expected, we should see oil prices remain downside-focused at the start of the new year.

Rand Update

In starting the first report of 2023, we wish all readers a healthy and prosperous year ahead. Recent comments from IMF Director Kristalina Georgieva reflect the challenges this year will bring, with her expectation being that the global economy is in for a tough time as the main engines of growth all face significant headwinds. The full impact of last year's aggressive monetary tightening cycle will be felt more completely in the real economy through the coming months, and while this portends a global economic downturn, it also points to the beginning of a new rate-cutting cycle down the line to support recovery.

In the more immediate future, the focus is on China's ongoing pandemic exit. Chinese President Xi said on Saturday that the country is in a new phase of Covid control as he urged perseverance and solidarity to overcome the pandemic. Despite pressure from surging Covid infections, Xi's speech suggests a return to strict lockdowns is unlikely. The economic burden of past lockdowns has forced China to move on from the pandemic and take on a new approach of living with Covid. Notwithstanding some short-term pressures as China battles through its 'exit wave', a degree of natural immunity will eventually be achieved and followed by a reopening boost for the economy.

As the market navigates crosscurrents related to China's chaotic pandemic exit and the final stretch of the global monetary tightening cycle, volatility will likely be the order of the day through the early stages of Q1. The ZAR will not enjoy any rotations to safety during times of heightened uncertainty, but does hold the potential to take advantage of growing USD vulnerability as the monetary cycle nears an end. It is currently trading comfortably around the R17.0000/$ handle in holiday-thinned liquidity conditions, with the longer-term balance of risks tilted slightly in favour of the ZAR bulls as the USD's overvaluation remains unsustainably stretched.

Bond Update

Bonds/Yield Curve: As the ZAR trades comfortably back below the 17.00/dlr handle, the prospects for inflation improve considerably. Bonds have adopted a more bid tone and will likely strengthen further through the months ahead. With yields as high as they are and with SA's carry attractiveness raising the prospects for gains, the ZAR may hold the key to unlocking tremendous value from the bond market. Long-only fund managers are long duration and will seek to lock in inflation-beating yields and position for capital gains. Expectations are high that bonds will outperform equities this year as bonds offer attractive returns against a backdrop that will detract from corporate earnings.

FRAs: Steadily, the FRA curve will price out the need for the SARB to continue hiking. With the ZAR recovering and fuel prices dropping sharply, the prospects for inflation improve considerably. A receiving interest has been noted in recent trading sessions, and notably, the 1X4 vs 12X15 spread has compressed to just 19bp. As the months unfold, this will tilt to a negative spread, especially as domestic interest rates peak. For now, a combination of the ZAR's performance, the inflation trajectory and GDP growth prospects will be key.

Repo: The SARB has thus far kept in lockstep with the Fed to ensure that negative speculation against the ZAR is discouraged. They have been successful in that, and their conservative stance on monetary policy means that the monetary space for inflation to take hold no longer exists. There may be one more 50bp hike at the first meeting of 2023, but after that, the SARB may signal that they have done enough.

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