Mizuho daily – Seeing is believing

By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Seeing is Believing

“Well now that we have seen each other,” said the unicorn, “if you’ll believe in me, I’ll believe in you” – Lewis Carroll, Through the Looking-Glass and What Alice Found There

You better believe it. Oil prices were elevated despite upbeat OPEC+ oil demand assessment, which ought to have been conflated with possible supply response.

Elsewhere, UST yields slipped despite higher Oil and Fed speakers hinting at starting to plan for “taper”. What’s more, despite blockbuster Q1 GDP (and softer UST yields) AUD was subdued at mid-0.77.

Seeing may indeed be believing, but it does not absolve us of the need to reason.

On UST yields, it may very well be that markets have come to the conclusion that seeing (the walk) is believing (the talk) when it comes to near-term taper risks. Admittedly, even for a non-voting member, Fed Harker’s call “to at least think about thinking about tapering” arguably ought to have rattled bonds. But that it hasn’t, speaks to UST yields already (partly) reflecting reflation risks and factoring the Fed’s “running hot” paradigm shift.

In any case, the “seeing is believing” principle points to potentially de-stabilising (especially for EM) market adjustments when “taper” does make a comeback.

Meanwhile, we have a modestly firmer USD which has surrendered most of the reflex surge in European hours; allowing EUR to recover from fleeting sub-1.22 slip.

USD/JPY consolidates mid- to high-109 range and USD/SGD has stalled ahead of early week attempts to break below 1.32.

In which case, AUD suppression despite upbeat GDP is arguably suggestive of the RBA’s dovish bias that is even more emphatic than the Fed’s. Notably, the RBA ruling out rate hikes till 2024; looking through current cost-push to believe inflation only when it sees it durably in wages.

On oil, “I will believe it when I see it” was Saudi Energy Minister Prince Abdulaziz’s response to whether more supply increases will be warranted by forecasted shortfall in OPEC+ output resumption vis-a-vis demand recovery for H2 2021; as flagged by the IEA’s May report.

This suggests that the OPEC+ would much rather respond belatedly to hard evidence that validate IEA’s vies that “current OPEC+ – won’t rise fast enough to keep pace with expected demand recovery” than to pre-emptively crank up the pace of supply restoration.

And this provides context for the cartel’s upbeat assessment (at the June OPEC+ meet) that “the ongoing strengthening of market fundamentals, with oil demand showing clear signs of improvement … as the economic recovery continued in most parts of the world.”

Which is, while the OPEC+ is encouraged by, the path of global economic (and attendant oil demand) recovery, it is far from assured of unfettered stability in oil prices.

For one, the demand recovery narrative is recognized as an uneven and bumpy one.

India’s Q2 Covid devastation denting oil demand pick-up, while likely a temporary setback, continues to be a cautionary tale amid spots of Covid re-emergence globally.

What’s more, Saudi also appears to supply responses/catch-up outside of OPEC+. Notably, oil prices have been boosted by delayed Iranian supply corresponding to a stall in the prospects for a nuclear deal with Iran being re-established.

Which is to say, Saudi is acutely aware that this “Iranian boost” to prices is but temporary. And this is over and above growing incentives for marginal producers in the US/elsewhere to start pumping as oil prices climb.

All said, while Saudi’s cautious supply restoration amid supply kinks and demand recovery suggest buoyant Oil prices (with Brent potentially testing $80), a supply response that eventually anchors oil more durably in the $65 80 range into mid-2022 is more likely.

Credit: Mizuho Bank Ltd