OPEC+ Surprises, While Manufacturing Remains Challenged

Overview

News of OPEC+ unexpected output cuts saw May WTI gap sharply higher and helped lift bond yields. May WTI settled near three-week highs before the weekend near $75.65, and opened today near $80. It reached almost $81.70 before stabilizing, and is straddling the $80 area before the North American session. The high for the year was set in the second half of January around $83. Benchmark 10-year yields are up 2-5 bp. The 10-year US Treasury yield is near 3.52%, which is near the middle of the pre-weekend range. Equity markets are higher. Most Asia-Pacific markets advanced, with South Korea's Kospi a notable exception after poor March trade figures. Europe's STOXX 600 is edging higher to extend its rally to the fourth consecutive session. European bank shares are 1.6% higher after a 0.25% pullback before the weekend. US equity futures are trading lower.

The US dollar is mixed. The New Zealand dollar joins the Japanese yen and Swiss franc on the downside, while the Scandis and Australian and Canadian dollars lead the advancers. Emerging market currencies are mostly lower, though the Hungarian forint and Mexican peso are the best performers. The Dollar Index opened higher (~102.65) and ran up to a slightly through 103.00 before coming under pressure, and is little changed near 102.55 in the European dealings. Gold gapped lower and fell around $1950 before bouncing back. It is practically unchanged near $1969 after having closed the gap.

Asia-Pacific

The Bank of Japan announced the range of bond purchases for Q2. The range had been JPY200-400 billion in Q1. If the range had been extended on the downside, many observers would have seen this as a likely sign of a pending change in policy as the central bank's new leadership takes over. However, in a savvy move, the BOJ widened the range to JPY100-500 billion of the 10-25 year JGBs it will purchase. Recall that the BOJ conducts two types of bond purchases. The first is a fixed amount at prevailing yields. This is its "normal" QE. The second is at a fixed yield and is ostensibly of unlimited quantities. This is the defense of the 0.50% top of the band of the 10-year bond under the terms of Yield Curve Control. Separately, the Tankan survey was mixed. The manufacturing sector sentiment deteriorated with the non-manufacturing sector ticked up. This is consistent with the PMI. The final manufacturing PMI stood at 49.2, up from 48.6 in the preliminary reading and 47.7 in February. It has not been above 50 since October. The big miss was in capital expenditure plans. They rose 3.2% after 19.2% last quarter and expectations for 14.2%.

The Reserve Bank of Australia meets tomorrow. The futures market is pricing in a pause with the overnight cash rate at 3.60%. The Bloomberg survey of economists is split but favors a pause 19-11. The final March manufacturing PMI was revised slightly higher from the flash reading of 48.7 to 49.1 but confirming the first sub-50 reading since March 2020. Separately, house prices posted their first gain (month-over-month) since last April. A challenge for officials and homeowners is that an estimated 90% of mortgages will float this year after the 2-3 year fixed period expires. Mortgage payments could rise by a third.

The dollar edged higher against the yen. The pre-weekend high was near JPY133.60, and today's high has been about JPY133.75. Today's high corresponds to the (61.8%) retracement of the greenback's drop from the March 8 high near JPY138.00. Rising US rates seem to be helping the US dollar's recovery. This is its third gain in four sessions. We suspect there is scope for a retest on the JPY135 area in the coming days. The Australian dollar is recovering from four-day lows set in the Asia-Pacific session today (~$0.6650) and made new highs in the European morning above $0.6700. The high at the end of last week was closer to $0.6740, and then there is the 200-day moving average (~$0.6750) that checked the Aussie last month. Still, caution may be in order ahead of tomorrow's RBA meeting and given that the intraday momentum indicators are stretched. The US dollar is trading higher against the Chinese yuan. Recall that before the weekend, the dollar recovered from the week's lows (~CNY6.8445) and settled at its session highs (~CNY6.8765). Today, it traded to CNY6.8945. The Caixin manufacturing PMI slipped to 50.0 from 51.6. The PBOC set the dollar's reference rate at CNY6.8805, tight to expectations (CNY6.8802).

Europe

May WTI settled near $75.65 before the weekend, around a three-week high. Several OPEC+ countries surprised yesterday by announcing a cut in output starting next month and running through the end of the year. Saudi Arabia and Russia announced cuts of 500k barrels a day. Russia extended the unilateral cut it announced in February. At the time, the US argued that the unilateral cuts were a sign that Moscow's relations with OPEC were strained, but this surprise seems to counter that. Several others announced reductions of another 650 million barrels a day. These cuts come on top of the 2 million announced last October. The OPEC+ ministerial meeting today was expected to roll over the October agreement. Saudi officials said the new cuts are intended as a precautionary measure to help stabilize oil prices. It would seem to be predicated on concerns about demand, though the downside tail risks of an energy crisis in Europe this winter and a prolonged recession in the UK have eased. China's economic rebound appears intact, with the strength of construction blunting the softness in manufacturing. The Biden administration had previously indicated it would refill the Strategic Petroleum Reserves when prices fell to $67-72 a barrel. Still, it hesitated - in part, it seems, because an earlier budget deal included a sale of 26 million barrels of crude, and four SPR sites are undergoing routine maintenance. Separately, the EU ban on Russian oil products has diverted products like diesel to Asia, creating a glut.

Meanwhile, on another front, we have noted previously the G7, EU, and Australia granted an exception to Japan to the $60 cap on Russian oil. The main product of Sakhalin-2 (of which 22.5% is owned by two Japanese companies) is natural gas, but a small quantity of oil is extracted too. In January-February this year, Japan bought almost 750k barrels of Russian oil for JPY6.9 billion, which translates, at current exchange rates, to a little less than $7. Purchases of natural gas from Sakhalin-2 rose by about 4.5% in 2022 over 2021. Yet, at the end of last week, Tokyo announced expanded bands on exports to Russia to include drones, metals, optical and measuring devices, boilers and machinery, construction equipment, and vehicles. In addition, air- and spacecraft and parts. In addition, Japan holds the rotating G7 presidency and has invited Ukraine President Zelensky to attend the G7 summit in May (virtually), which will be held in Hiroshima.

The eurozone final manufacturing PMI edged up to 47.3 from the initial estimate of 47.1 and 48.5 in February. It has not been above 50 since last June. The German reading was revised to 44.7 from 44.4, but it is still the lows since the early days of the pandemic. The final French reading came in lower at 47.3 from the preliminary estimate of 47.7 (and 47.7 in February). Last year's low was hit in October at 47.2. Italy's manufacturing PMI came in at 51.1, slightly better than expected but slower than the 52.0 in February. Spain's manufacturing PMI stands at 51.3, up from 50.7. The median forecast in Bloomberg looked for a decline. It is the highest since last June. Lastly, note that the UK's final manufacturing PMI slipped to 47.9 from 48.0 flash estimate. It stood at 49.3 in February, and it has not been above 50 since last July.

After reversing lower before the weekend and settling at its lows (slightly above $1.0835), the euro fell to a little below $1.0790 in early Asia-Pacific turnover. However, it recovered smartly to trade to almost $1.0855 in the European morning. This stretched the intraday momentum indicators. There are almost 600 million euro in options expiring today at $1.0850 and a larger set (1.2 billion euros) at $1.09. Similarly, sterling poked above $1.24 ahead of the weekend but settled softly near $1.2335. It fell back to $1.2275 today before recovering to new session highs in Europe slightly above $1.2340. Here too, the intraday momentum indicators are stretched. There are two set of option expirations of note. The first one is for GBP580 million at $1.2400 and the other is for GBP425 million at $1.2425. Pre-weekend position adjustment may have neutralized some of the exposure, but they may be too far away, given the intraday momentum, to be pressed today.

America

Arguably, the key issue is the magnitude and duration of the tightening of US bank lending. Yes, the monthly nonfarm payrolls are due at the end of the week. But between the weekly jobless claim, other survey data, and the assessment of several Fed officials, the labor market remains resilient. The Federal Reserve's H.8 report includes an update on lending. Primarily driven by a decline in commercial and industry lows, bank lending fell by $20.4 billion in the latest week, which is the most in two years. We have noted bank shares have stabilized after the rout earlier last month, but emergency borrowing from the Fed (between the discount window and the new Bank Term Funding Program) remains high (~$152.6 billion in the week through March 29 from almost $164 billion in the previous week). At the same time, the H.8 report showed that commercial banks continue to leak deposits for the ninth consecutive week. However, in the most recent report, the deposit exodus was from the large banks. Small banks saw an increase in deposits. Ahead of the weekend, S&P Global Ratings cut the credit outlook of four large US banks to stable from positive, citing the "prevailing market and economic conditions," which make upgrades seem less likely while affirming their current ratings.

Late last week, the International Court of Justice (World Court) ruled against the US on Iran's complaint (from 2016) about freezing some Iranian corporate assets. It ordered the US to compensate Iran, but no amount has been announced yet. The two parties have two years to work out the amount. If no agreement is reached, the new World Court proceedings would be conducted and an amount set. ICJ also said it did not have jurisdiction over the $1.75 central bank assets that were frozen as well. Iran claimed protection under a treaty of friendship signed in the 1950s. The US formally pulled out of the treaty in 2018. In 2016, the US Supreme Court ruled that $2 billion of Iranian assets could be used to compensate the families of US marines killed in the 1983 attack on the US marine base in Beirut. The World Court's decisions are difficult to enforce.

The US reports its final manufacturing PMI today. The flash reading stood at 49.3, which was its best reading since October 2022, when it was last above 50. The March manufacturing ISM is also on tap and February construction spending. Auto sales will also be reported, and a slightly slower pace than February's annualized rate of 14.89 million is expected. The highlight of the week is Friday's jobs report, and the current median in Bloomberg's survey is for a gain of 240k. Canada sees its manufacturing PMI and Bank of Canada surveys. Its March employment report will be released on Thursday, ahead of Friday's holiday. Job growth is expected to slow to 15k from 21.8k in February. Mexico reports its PMI and IMEF survey and worker remittances (median forecast is for $4.3 billion after $4.4 billion in January).

The US dollar is extending its slide against the Canadian dollar for the sixth consecutive session. It fell 1.65% last week, the largest weekly loss since last October. It has broken below CAD1.3500, which is a (61.8%) retracement of the greenback's gains from the mid-February low (~CAD1.3275). The next area of chart support is around CAD1.3440. There are options for around $400 million struck at CAD1.3450 that expire today. However, note that the lower Bollinger Band is slightly below CAD1.3490. Meanwhile, the greenback drew nearer the multi-year lows set against the Mexican peso in the first half of March near MXN17.8980. It reached about MXN17.9780 in the European morning. The greenback has risen in only two sessions since March 17, and both gains were less than 0.1%. The intraday momentum indicators are overextended. Initial resistance is seen near MXN18.05-06.

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