Upside risks for USD from oil supply disruption remain in place

USD: Oil supply concerns contributing to stronger USD

The US dollar has strengthened overnight encouraged by the price of oil moving back above USD100/barrel. The price action continues to highlight that market participants remain concerned over the risk of a bigger and more prolonged negative energy price shock for the global economy. Those concerns have been reinforced overnight by reports that Oman’s key oil export terminal was evacuated and two crude tankers were hit in Iraqi waters. Ships were ordered to leave the port of Mina Al Fahal in Oman as a precautionary measure according to people who directly received a notice from a port agent. It follows drone attacks at other ports in the country on Wednesday. The evacuation at Mina Al Fahal, which sits outside the Strait of Hormuz, highlights how the conflict is now threatening the few ports from which Middle Eastern oil can still be shipped from while the Strait of Hormuz remains effectively closed. According to Bloomberg, around 1 million barrels/day of Omani oil are exported from Mina Al Fahal. The director of the General Company for Ports of Iraq also stated that the country has stopped operations at its oil terminals after two crude tankers were hit in its territorial waters.

Fresh disruption to global oil supply will keep upward pressure on prices limiting the dampening impact from yesterday’s announcement from the International Energy Agency (IEA) that they have agreed to discharge a record 400 million barrels from reserves. It compares to the releases totalling 183 million barrels in 2022 after the Ukraine conflict disrupted global supply. It would be roughly equivalent to around 3-4 weeks of oil supply that normally passes through the Strait of Hormuz. However, it will take time for the reserves to be released which is the main problem in addressing the current supply bottleneck. Bloomberg has reported that traders and analysts at large commodity trading houses and hedge funds have estimated that between 2 million and 4 million barrels per day may hit the market this time around. That would still represent only a small proportion of lost daily flow that has been taken off the market considering that around 15-20 million barrels/day normally passed through the Strait of Hormuz. As a result, we are not confident that we have seen the worst of the oil price spike. It is one of the reasons why we recommended a short EUR/USD trade idea in our latest FX Weekly report (click here).

POSITIVE CORRELATION BETWEEN PERFORMANCE OF USD & OIL PRICE

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Higher bar for intervention amidst energy price shock?

The yen has been one of the worst performing G10 currencies since the Middle East conflict started alongside the European currencies of the euro and Swedish krona. It has weakened by almost 2% against the US dollar lifting USD/JPY back up closer to the year to date highs from January at just below 159.50. On that occasion, verbal intervention was stepped up significantly including rate checks carried out by the New York Fed to prevent USD/JPY from rising back above the 160.00-level. In contrast, the lack of verbal intervention from Japanese policymakers overnight was notable which indicates that less immediate concern. Yen weakness is more fundamentally driven given the negative terms of trade shock for Japan from higher energy prices. As a result, Japan may be more tolerant of allowing a weaker yen in the near-term even though it will reinforce upside inflation risks alongside higher energy prices. It potentially creates a higher bar for intervention that could require more concern over the pace of yen weakness and evidence of speculative selling.

Yen weakness if one reason why BoJ watchers still expect the BoJ to hike rates again as soon at the April policy meeting. The latest Bloomberg survey of Japan economists revealed that 37% now expect the BoJ to hike again in April up from 17% from the previous survey two months ago. Back in January, 48% of participants expected the BoJ to wait until July to hike rates this year. It compares to current Japanese rate market pricing which is attaching around a 60% probability of a hike in April. However, around half of survey participants judged that the Iran conflict could make the BoJ more cautious over hiking rates again as soon as April by increasing downside risks to Japan’s economy due to the hit from higher energy prices.

Yen weakness would likely extend further if the BoJ refrains from hiking rates in April especially at a time when a hawkish repricing is underway in other government bond markets outside of Japan. The BoE and ECB are now expected to deliver 1-2 hikes this year in response to the energy price shock. BoJ Governor Ueda was speaking in parliament overnight when he emphasized that FX is a key factor that affects prices, and is affecting prices more than before. The comments suggest yen weakness supports market expectations for an April hike. Apart from intervention, the main risk to the weaker yen trend would be an unwind of yen-funded carry trades triggered by the energy price spike (click here).               

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com