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Having warned followers of our Facebook page on 1/5/18 that the rising US Yields and stronger dollar would likely hit emerging markets FX and Bonds, we have seen our first two casualties in the market, being Argentina and Indonesia this week, with Russia also on the rocks.
The Central Bank of Argentina have hiked the 7 day reference repo rate to 40% on Friday following previous two hikes earlier this week thatwhich have failed to stem the fall in the Argentina Peso against the dollar, which is down 10% on the week.
BCRA hiked three times this week:
4/27 +300bps to 30.25%
5/03 +300bps to 33.25%
5/04 +675bps to 40.00%
The central bank said it will continue to use all tools at its disposal to avoid disruptions in the markets and guarantee a slowdown in inflation. The bank is ready to act again if necessary, it said in the statement. We are truly amazed at how one can repeat similar actions which have obviously failed, in hopes of getting a different outcome. We call this insanity. If only the Central bank of Argentina is as good as the Argentina football team, or Argentina steakhouse.
We are seeing similar moves in Asia closer to home, starting with the Jakarta Composite Index and the Indonesia Rupiah. Indonesia Equity Index is down 10% in the past 2 weeks, while the Rupiah is down 3% against the dollar, proving our prediction of outflows in Asia correct.
We are confident on our analysis that the US Dollar is the global funding currency in the past two years, even when the Fed Funds Rate is higher compared to other global currencies like the Euro , UK Pound or Japanese Yen which have lower interest rates in the past two years.
Various reason as below
1.The broad based decline of the dollar value against major currencies in the past two years on expectations of other nations central banks being next to hike rates have had the dollar remained as funding currency.
2. Abudance of liquidity in the US lending markets even when the federal reserve hike rates since 2016. From 2016 - 2018, the fed still operate on a large balance sheet of assets they had purchased on their quantitative easing operations. This can be reflected on a stable outlook for long term yields, in particular the 10Y and 30Y US Benchmark.
3.Its only when the FRB proceed with Quantitative Tightening in early 2018 by selling balance sheet assets did we see a tightening of financial conditions in the markets. As below is a chart by the Federal Reserve Bank of St Louis proving the point. A stronger dollar effect was only priced in the past two weeks after media focus on the higher 10Y Yields.
We expect this move to have just began as we look at a broader base hit on emerging markets and Asia. We remain bearish on the Hang Seng Index due to rising Hibor rates from the HKD intervention by the Hong Kong Monetary Authority which have indirectly caused domestic rates to increase. Rising rates in Asia due to USD Carry Trades outflow will not spare most of East and South East Asian markets, in which we have been calling for caution to existing longs to take profits.
A look at Major Asian Equity Indices show toppish chart patterns in which we are certain the catalyst for the break lower will be the continued dollar strength and USD Carry Trade unwind.
To end of this week Macro Note before we move next to the oil markets and effects on rig builders, we just saw the following headline out of KCNA which makes things very interesting going forward for risk off havens like Precious Metals and Yen. We remain bullish silver as our blog post last week
NORTH KOREA CLAIMS U.S. MISLEADING PUBLIC ON DENUCLEARIZATION: KCNA
We guess this GIF sums up the current scenario well.
A look at the current Oil Futures Curve and effects on Rig builders.
A look at energy sector this week as WTI Crude Oil approaches the $70/Barrel mark. We have seen many hype on rising oil prices which had called for rising prices to Oil related stocks listed in the local Singapore Exchange market among the Facebook groups we share our weekly blog post with and decided to take a look at why these stocks are not rising penny for penny along with rising Crude Oil prices.
Two of the worlds largest Oil Rig makers are listed in the Singapore Exchange, namely Sembcorp Marine and Keppel Corp ( Keppel Offshore and Marine).
Many of Singaporean investors who are not well versed in global investing would be limited to these two stocks for energy sector exposure.
Much of the revenue from these two stocks would be from Rig orders from major oil producers globally. Off-Shore oil rig producers have the highest cost per barrel output of around $50/Barrel. However for companies to increase Capex and order more Rigs, they will need to look at $80/barrel of oil sales before moving ahead as qouted by Rystad Energy.
Now, lets take a look at oil prices. WTI Crude have closed at the highest level since October 2014, last at $69.79/barrel.
Prices have been trending higher on news of possible break of the Iran Nuclear Deal, alongside Saudi Aramco IPO in 2019 in which Saudi Arabia has the incentive to push oil prices higher to maximize IPO returns.
However, with regards to Rig Markers, we felt it was misleading to just look at front month crude oil contract prices as energy corporate Capex is higher dependent on predicted future earnings. We took at look at the WTI Crude Oil Futures Curve on the CME as below and seem to have found the reason for the weak demand in rig orders even as we approach near the $70/Barrel Mark.
The large backwardation on the crude oil curve is likely the reason for slower Capex orders from oil producers with regards to weaker sales to Rig makers. This is due to most oil producers would not be confident to invest more on capital spending given how the market price in the lower future prices of oil at this stage.
2 Year forward prices for Crude Oil stands at $12 lower than current month prices, way below the $70-$80 mark which is expected for higher capex spending.
Another reason this time is different from the 2006-2008 boom in crude oil prices would be that most of the oil producers currently would already have the infrastructure needed to produce oil, compared to the boom days previously in which oil producers rush to order oil rigs on rising prices. The average lifespan of a Oil Rig stands at 30-40 years and thus its likely most of the revenue major oil rig makers would derive in the next 5 years would be from repairs of rigs or boats. This would put a halt to increasing revenue as oil rigs manufacturing demands most of the revenue generated to overall profits.
We thus recommend readers who are bullish crude oil, to increase exposure by going long Crude Oil Futures or Long Oil Exposure ETF which are commonly listed in the US markets, in which this large backwardation is beneficial to holders of Long Oil ETF as the rolling operation of front month long futures contracts.
Good Luck trading!
The Bad Bear