Today’s podcast

https://soundcloud.com/user-291029717/oil-slides-as-production-returns?in=user-291029717/sets/the-morning-call

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Overview: Stayin’ alive

• Oil slides (Brent -7.1% to $64.15) with Saudi production expected to be fully back online in 2-3 weeks
• US repo rates spike; Fed injects $53.2bn via overnight repo for the first time in a decade – another will occur tomorrow
• USD (DXY) down -0.4% ahead of the FOMC later tonight, US 10yr yields -4.2bps to 1.80%
• AUD initially soft, but reversed losses on USD weakness to be unchanged at 0.6866
• RBA Minutes yesterday very dovish – markets now price 40% chance of an Oct cut, 95% by Nov
• Coming up today: NZ BoP, UK CPI, US FOMC (25bps Rate Cut, focus on framing)

The oil price was the biggest mover this morning with Brent sliding some -7.1% to $64.11 on news that Saudi oil production will be fully back online in 2-3 weeks. In the words of the Bee Gee’s 1977 hit, oil production is Stayin’ Alive. The other significant event overnight has been in the repo market where rates spiked, forcing the Fed to inject some $53.2bn via overnight system repo for the first time in a decade. The move is being seen as more of a plumbing issue and it is likely there will be further Fed intervention in the market – another operation is scheduled for tomorrow (see below for details). In FX it has been a story of USD weakness with DXY -0.4%, partly driving is the lower oil price with oil-importers less likely to come under stress – particularly EM. Gains were seen in EUR (+0.6% to 1.1073) and GBP (+0.6% to 1.2499), while USD weakness reversed the decline in the AUD seen yesterday following the Yuan fix and the dovish RBA Minutes. Equities have largely drifted with the S&P500 +0.3% in a late surge, while US Treasury yields are lower ahead of the FOMC later tonight. Markets are around 86% priced for a cut, with initial focus on the dot plot and then to the press conference to determine whether the Fed is still seeing this as a mid-cycle adjustment or more of a protracted easing cycle.

First to oil. Saudi oil production is set to come back online quicker than expected. Reuters initially reported that normal oil production would be resumed within 2-3 weeks with around 70% of lost production having been restored already. Those sentiments were later confirmed by Saudi Energy Minister Salman who said production will reach 11m barrels per day by the end of September and full capacity of 12m barrels will be restored by the end of October – note that the drone strike initially took some 5.7m barrels out of circulation. Oil has consequently fallen sharply with Brent -7.1% to $64.11 and WTI -6.2% to $59.02. There was little sustained reaction to reports that the US had identified exact locations in Iran from which a combination of drones and missiles were allegedly launched. Given the heightened geopolitical tensions though, we would still expect oil to trade with a higher risk premium then previously even as Saudi production comes back online.

US repo markets were under the spotlight last night with extreme spikes in repo rates (opening at 3.8% but getting as high as 10%) spilling over to the Effective Fed Funds Rate which the Fed uses to implement policy (effective fed funds went from 2.14% on Friday to 2.25% on Monday and likely much higher today – note the Fed publishes transacted rates the next day). To stem the rise the Fed undertook its first overnight system repo in a decade with $53.2bn injected and the Fed has flagged another repo operation for tomorrow capped at $75bn. As for the drivers of higher repo, markets are citing a number of factors including a shortage of FICC sponsored cash (companies pulling cash out in order to pay tax bills), corporate bond issuance and a step up in Treasury issuance, low reserve levels in the banking system, and reports of Saudi cash being pulled out of US markets to support their economy following the drone strike. With the Effective Fed Funds Rate likely outside of the current 2.00-2.25% target range, it is also possible that the FOMC also cuts the IOER rate by more than 25bps today.

Data overnight was mostly second tier. US Industrial Production was stronger than expected in August at +0.6% m/m against 0.2% expected and -0.1% previously. However there were some one-off factors with oil production up +2.6% m/m and the ISM Manufacturing Survey continues to point to dire conditions in the manufacturing sector. Highlighting that overnight was earnings by FedEx whose first quarter results missed expectations as well as lowering guidance for 2020. Fed Ex CEO stated “our performance continues to be negatively impacted by a weakening global macro environment driven by increasing trade tensions and policy uncertainty”. In Germany the ZEW survey of analysts was a little better than expected with the expectations component at -22.5 against -38.0 expected, though it continues to remain firmly negative.

The RBA Minutes yesterday were more dovish than expected and paved the way for a near-term rate cut. A hat tip to my colleagues who were tipping a dovish framing and noting that the Minutes were now being used to convey the RBA’s key messaging as opposed to the post-meeting Statement. While NAB continues to expect the next 25bps cut in November, the Minutes raise the risk of an earlier October move if there is a material deterioration in Thursday’s labour market data – consensus there looks for an unchanged unemployment rate at 5.2%. Markets are pretty much 50/50 on Oct v Nov with October 40% priced and November 95% priced. As for the dovish leanings in the Minutes, the key policy paragraph dropped the reference to waiting for an “accumulation” of evidence in deciding to cut again, the RBA seemed more focused on downside risks to the global outlook and no longer cites a “reasonable” global outlook, while domestically the RBA’s liaison with retailers suggests tax refunds have not boosted spending.

The AUD fell as much as -0.6% in the wake of a weaker CNH (USD/CNH +0.3%) and the dovish RBA Minutes, but a lower oil price and USD weakness saw the losses fully reverse with the AUD unchanged at 0.6866 this morning. The USD was weaker across the board with DXY -0.4% 98.22, with the fall in the oil price alleviating some of the pressure on oil imports – particularly for emerging markets. EUR and GBP were both 0.6% higher, while USD/Yen was little moved at 108.13.

US yields were lower with 10yr Treasury yields -4.2bps to 1.80%. Yields though were higher in Europe, with Italian 10y BTP yields +7.9bps to 0.917% on news at former PM Matteo Renzi has split from the centre-left Democratic party (who has only just formed a coalition to govern) to create a new political party. The bigger driver for yields globally will be the FOMC meeting later tonight where focus will be on the framing of a likely rate cuts. Given divisions in the FOMC it is possible Powell is not as dovish as the markets would like (see coming up for details).

Coming up today

Domestic focus will be on the NAB Business Survey and then to the Chinese CPI/PPI. It is relatively quiet otherwise with little data of note out of the US.

• NZ: Current Account (10.45am local, 8.45am AEST): The Q2 current account is expected to be a deficit of -1.1bn.
• JN: Trade Balance (8.50am local, 9.50am AEST): Both exports and imports are expected to be down sharply y/y with exports -10.0% y/y and imports -10.7% y/y.
• EZ: CPI-final (11.00am local, 7.00pm AEST): Final CPI for August is expected to be 1.0% y/y with Core remaining even more subdued at 0.9% y/y.
• ECB’s Villeroy (5.15pm local, 1.15am AEST): Bank of France Governor Villeroy speaks, though unlikely to be market moving given he spoke yesterday.
• UK: CPI (9.30am local, 6.30pm AEST): Inflation data for August is expected to be 1.9% y/y for Headline and 1.8% y/y for Core. There is a fairly large left tail in the consensus so risks are more likely to the downside. The data though is unlikely to be market moving given the dominance of Brexit headlines.
• US: FOMC Decision (2.00pm local, 4.00am AEST): The Fed is expected to cut rates by 25bps, taking the Fed Funds Target to 1.75-2.00%. No one in the consensus is tipping a larger cut and the market is priced 86% for a cut. Consequently all focus will be on the framing of the cut as given in the Fed dot plot projections, and then to the press conference 30mins after the decision. There may also be 2 dissenters given Rosengren and George dissented to the July insurance cut. As for the dot plot, the projections in June showed only 7/17 had two cuts pencilled in for 2019. It is likely that at least some will have a third cut pencilled in for 2019 and if so would play to the market’s view of the Fed being on a protracted easing cycle, rather than as a mid-cycle adjustment as it is currently being framed. Given divisions in the FOMC it is possible Powell is not as dovish as the markets would like. We would also expect a few Trump tweets following the meeting, though these have had little impact recently.
• US: Housing Starts/Permits (8.30am, 10.30pm AEST):
• Oil: EIA Crude Oil Inventory Report: US oil production and inventories will likely be under greater focus given the reduction in supply out of Saudi Arabia.

Market prices

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