Oil reserve release will help as focus shifts to inflation

USD: FX moves remain contained as focus shifts to inflation

The Wall Street Journal is reporting that the IEA has proposed the largest ever release of oil reserves which may be an indication that an agreement has been reached amongst G7 for the release of 300-400mn barrels that had been under discussion since the surge in crude oil prices on Monday. Given that usually around 20mn barrels of oil are shipped through the Strait of Hormuz per day, the release will equate to fully compensating for the closure of the Strait for between 15-20 days. In reality, its longer than that as Saudi has shifted exports to the west coast so this action does help alleviate the supply constraint for a reasonable period of time. Indeed for a time that investors have likely been assuming this conflict would last – 3-4 weeks. The IEA’s 32 members will meet this morning to consider the IEA’s proposal.

There has certainly been no let-up in the intensity of the conflict with yesterday the heaviest day of missile attacks by the US and Israel according to Pete Hegseth and the reports of Iran retaliation have also continued. The UK navy reported earlier that Iran struck a cargo vessel in the Strait of Hormuz while the US has reported it destroyed 16 Iranian minelayers near the Strait of Hormuz. The use of mines could prompt a further escalation given President Trump’s warnings that the US would escalate further its attacks on Iran if it were to use mines in the Strait of Hormuz.

There has been a constant focus on trying to gauge the scale of the impact on inflation from the conflict as the inflation shock will determine the potential monetary policy response and the impact on economic growth. That focus will intensify further today with the release of the US CPI data for February. This will be the last US report before we begin to see the repercussions of the attack in the CPI data next month.

The consensus for today is for headline CPI to show a pick-up in the MoM gain from 0.2% to 0.3% but the core is expected to slow 0.1ppt to 0.2%. The annual rates are set to remain stable at 2.4% and 2.5% respectively.

Next month, energy is where we will see the impact come though quickly. US gasoline prices have surged quickly with the AAA national daily average gasoline price surging 18% in March to-date through to 9^th March, to the highest level since July 2024. The current energy weight in headline CPI as of December was 6.38% and if we run a scenario of Nymex crude moving higher to USD 100 p/bl in Q1-Q2 this year but then subsiding back to USD 70 p/bl by year-end it could translate to US energy CPI peaking at somewhere between 15-20% by mid-year. That pass-through would imply around a potential 1.0ppt lift to headline CPI, assuming natural gas price rises are more modest. US YoY energy CPI in Q4 was -20%.

Given the US labour market we would still assume the Fed would be much more reluctant to hike than in Europe. ECB President Lagarde yesterday stated that the ECB won’t allow a repeat of the 2022-23 energy price shock although did add that the euro-zone was in a better position to absorb shocks. ECB Council member Peter Kazimir today has just stated that a “reaction” from the ECB could be closer than the markets think, adding he didn’t want to “speculate about April or June”. BoE’s MPC member Sarah Breeden will speak in parliament today (speaking on stablecoins so may not address monetary policy) but we would assume tolerance to ride out an inflation shock will be pretty low here in the UK as well. These balance of risks could continue to limit US dollar buying as long as risk does not deteriorate notably. The performance of AUD does point to investors rewarding currencies where there are prospects of tightening policy. An RBA hike next week is priced now at 65% with a May hike fully priced.

US NYMEX PEAKING AT $100 IN Q2 COULD SEE YOY ENERGY CPI AT +15-20%

Source: Bloomberg, Macrobond & MUFG GMR

GBP: 2nd best performing G10 currency

The US dollar generally has strengthened by less than would have been expected in response to the start of hostilities in the Middle East and the surge in crude oil prices in response. The regression analysis we have conducted suggested that a 10% jump in crude oil prices would translate to a 0.7% drop in EUR/USD which based on the 50% surge in crude oil prices would have translated to a 3.5% drop in EUR/USD. The speed in which we have retraced from the scale of increase in crude oil prices may explain the more limited dollar move and indeed when we incorporate the retracement in crude oil, the net FX impact is more consistent with our analysis (crude +22%; EUR/USD -1.7% from closing levels on 27^th February).

The performance of the pound stands out. In fact, the pound is the third best performing G10 currency since the conflict began, with only the Australian and Canadian dollars  performing better. That is certainly somewhat surprising based on the most recent episode – the Russia-related energy shock in 2022. In the first month following the invasion of Ukraine, the pound was the third worst performing G10 currency and over three months it was still the third worst performing G10 currency. That said, over a longer period the regression analysis we used for EUR/USD above showed just a 0.1% drop for GBP/USD in response to a 10% jump in crude oil prices covering the post-US shale production period. The pound is now 0.4% weaker versus the US dollar from the closing level on 27^th February.

The scale of moves in crude oil and the fluidity of Middle East developments makes it more difficult to make any clear conclusions at this stage but one clear difference relative to the early stages of the Russia-Ukraine energy price shock was that the front-end of the UK yield curve dropped initially, over the first few weeks but of course on this occasion there was an immediate jump. The 2-year yield jumped 35bps last week.

The MPC will certainly be more wary of cutting rates given the fact that there are already a number of hawks who were concerned, prior to this energy price spike, about the continued stickiness of underlying inflation. Higher energy prices feeding into food would likely impact inflation expectations and potentially keep wage growth higher. The OIS curve now has only 5bps of cuts priced by year-end, down from 53bps prior to the conflict. Yield certainly appears to be providing the pound with support but whether that would persist is questionable given the potential hit to real incomes. Utility bill prices will however not be impacted until the next OFGEM price cap change in July with that price determined by natural gas prices between mid-Feb and mid-May. But mortgage rate increases and petrol pump price increases will happen quickly.

BIG JUMP IN 2-YEAR SWAP SPREAD IN FAVOUR OF GBP 

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com