MUFG: Ongoing oil price sell off challenges recent improvement in risk sentiment

April 20, 2020

Oil FX: Oil plunges to 21-year low

The main mover overnight has been the price of WTI oil which has plunged again to below USD15/barrel. In contrast, the price of Brent has remained more stable. It has triggered renewed weakness in oil-related currencies. USD/RUB and USD/NOK have both risen by almost 1.0%, and USD/CAD by around 0.7%. The sharp drop in the price of WTI oil has been driven by the imminent expiration of the WTI futures contract for May delivery. Contracts for WTI delivery in June were down by a smaller amount at around USD23/barrel. Near-term prices for WTI are trading at huge discounts to later dated contracts on concern the storage hub at Cushing, Oklahoma will fill to capacity. According to Bloomberg, buyers in Texas are offering as little as USD2 a barrel for some oil streams which raises the possibility that American producers may have to pay customers to take crude off their hands.

In his latest Oil Market Weekly our Middle East analyst Ehsan Khoman highlighted that whilst the OPEC+ production cuts have materially lessened the risk of storage being filled significantly and offering a smoother route to working off inventories, he still believes that storage will test capacity limits. It will require 3-4 million barrels/day of production shut-ins even before phase one of OPEC+’s 9.7 million barrels/day of cuts is expected to commence on the 1st May. The testing of storage capacity limits in the face of unprecedented demand weakness will force prices lower with our expectations for Brent to fall near cash-cost levels of USD20/barrel and WTI testing below USD10/barrel in the coming weeks.

In these circumstances, we expect oil-related currencies to come under renewed selling pressures during the second half of this month. In the G10 FX space, we expect USD/CAD to rise back towards last month’s highs at close to the 1.4500-level and USD/NOK to rise back towards the 11.000-level. Alongside the RUB, the NOK has staged the largest rebound over the past month which leaves both at higher risk of a sharper reversal lower.

EM FX: Risk spreading to EM?

The global picture on new COVID-19 cases continues to improve for the countries hit hardest with cases slowing in Europe and the US. The 5-day average daily percentage change slowed to 4.5% in the US, the slowest pace since the outbreak. Death from COVID-19 also slowed notably in Europe. The 433 reported deaths in Italy was the lowest total since 19th March while the 410 total in Spain was the lowest since 22nd March. France also recorded a smaller total – 395, which was the lowest since 29th March. So the slowdown in new cases that has been in place for some time is now beginning to show up in the number of deaths – welcome news indeed.

However, the concern looking at the data from over the weekend is the emerging signs of a further acceleration in the growth of new cases in countries elsewhere.

Singapore recorded 942 new cases on Saturday, the largest one-day total there. Russia also appears to be seeing a pick-up with 6,060 new cases reported yesterday, a daily percentage increase of 16.5%. India recorded 1,250 new cases (+7.6%); Saudi Arabia 1.088 (+13%); Qatar 440 +8.8%); and UAE 470 (+7.6%) underlining growing risks in the Middle East. This is particularly unwelcome when you consider the continued plunge in crude oil prices. NYMEX is down 19% as I write following the 20% drop in price last week.

Equity markets are currently priced for the rollback of lockdowns slowly taking place from now onwards but if we see a continued pick-up in cases in EM countries the prospect of a renewed hit to global growth projections is high. In addition, the risk of re-infection in countries that have tackled COVID-19 is also high.

These risks of potentially hitting investor sentiment are also high given the disappointment following the less than convincing agreements reached last week at the IMF to support EM countries through this crisis. The IMF last week predicted thatEM countries would need USD 2.5trn of financing and while measures were agreed including the establishment of a temporary US dollar liquidity line; the G20 debt relief plan and financing via the World Bank of USD 160bn, the IMF acknowledged that more will need to be done.

The COVID-19 data over recent days suggests that this need for more to be done could prove more urgent than expected and could prove to be a destabilising factor for financial markets if the data continues to show higher rates of infection like in recent days.