Risk of more disruptive energy price shock is increasing

USD: Energy supply concerns & Fed update support stronger US dollar

The US dollar has continued to strengthen overnight resulting in the dollar index rising back above 100.00. The US dollar’s renewed upward momentum was triggered by yesterday’s military strikes on energy sites in the Middle East which has reinforced market concerns over greater supply disruption. In response the price of Brent has risen to a high overnight of USD115.10/barrel. Energy supply disruption risks escalated yesterday after Israel attacked the South Pars gas field. It is the world’s largest natural gas field and is shared between Iran and Qatar. It prompted Iran to retaliate by striking Qatar’s Ras Laffan Industrial City which is home to the world’s largest liquefied natural gas export plant. It has reportedly suffered “extensive damage”.  Iran also reportedly attempted attacks on Saudi infrastructure as well. The latest developments have increased the risk of a bigger and more prolonged energy price shock alongside the ongoing closure on the Strait of Hormuz. The attacks on energy sites even drew criticism from President Trump who posted on social media that the US was not involved in the South Pars attack, and that Israel should refrain from further strikes on the site. He also warned Iran that any further attacks on Qatar’s LNG facilities would prompt the US to “massively blow up the entirety” of the South Pars field. Overall, we continue to judge that risks remain heavily tilted to the upside for energy prices and the US dollar given the unprecedented hit to global energy supply

In light of these developments, it is not surprising that the Fed’s latest policy update overnight was largely overshadowed. Fed Chair Powell emphasized that it was still too soon to judge the effects of the energy price shock on the US economy. He emphasized though that “the thing that’s really important that we see this year is progress on inflation. If we don’t see that progress, then you’ won’t see the rate cut”. The comments are consistent with the ongoing hawkish repricing in the US rate market which has moved to scale back Fed rate cut expectations. There are now only around 11bps of cuts priced in by year end to reflect upside risks to inflation from higher energy prices. For now at least the Fed is still sticking to plans for one further cut this year. The updated DOT plot revealed that a majority of 12 out of 19 FOMC participants still favoured lower rates this year although Chair Powell did emphasize not to put as much focus on the updated projections in light of heightened uncertainty from developments in the Middle East. He signalled that the response to the energy shock will depend on how inflation expectations react. On the other hand, he sounded less confident over the health of the US labour market adding it does have a “feel of downside risk”. He acknowledged that the Fed’s dual mandate of targeting inflation and full employment puts them in a difficult position as they need to balance risks. Overall, the scaling back of Fed rate cut expectations is another supportive factor for the US dollar triggered by the Middle East conflict.    

ENERGY SUPPLY DISRUPTION FEARS INTENSIFY

Source: Bloomberg, Macrobond & MUFG GMR

JPY: BoJ leaves door open to April hike offering some support for yen

The yen has held up better against the US dollar overnight supported by the BoJ’s latest policy update and further verbal intervention from Japanese policymakers. It has helped to prevent USD/JPY from rising above the 160.00-level after hitting a high of 159.87. Finance Minister Katayama reiterated that they are “prepared to do utmost to respond to FX moves any time”, and that they “have a high sense of urgency against FX moves”. The comments indicate a high risk of Japan intervening if USD/JPY rises back above the 160.00-level and moves closer to the high from July 2024 at 161.95.     

BoJ Governor Ueda acknowledged at today’s policy meeting that the rise in oil prices will put upward pressure on inflation in Japan. As a result, “slightly more” board members noted upside risks for prices. He still expects the inflation trend to rise gradually and will watch the impact of oil prices on the inflation trend. He added that higher oil prices could raise inflation expectations.  He repeated guidance that the BoJ plans to keep raising rates if their economic outlook materializes. On the other hand, he also noted that high oil prices would weigh on the economy if prolonged. The updated guidance leaves the door open for another hike as soon as the next policy meeting in April although there was not a clear signal it will be delivered. Instead, Governor Ueda signalled that they will decide policy meeting by meeting. The BoJ’s next policy meeting is not until 28^th April and a lot could happen before then in the current environment, so it makes sense that the BoJ did not strongly commit an April hike today.  A bigger and more disruptive energy price shock could yet discourage the BoJ from hiking rates again as soon as next month.

Governor Ueda  also highlighted that the BoJ is closely watching yen weakness. He stated that the weaker yen may boost inflation expectations alongside higher energy prices. He emphasized that the BoJ need to watch the impact of FX on prices, and reiterated that FX may have more impact on prices compared with earlier periods. The weaker yen is continuing to put pressure on the BoJ to hike rates further. While today’s BoJ policy update leaned more on the hawkish side, it is unlikely to be sufficient on its own to reverse the yen’s weakening trend.     

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com