Asia open: Oil deal and virus headcount set the agenda

Drop in COVID-19 lethality headcount keeps the pipe dream alive 

Even though oil prices cratered at the open and Japan is set to declare a state of emergency, US stocks advanced after the daily reported death toll eased on Sunday in some major cluster spots around the world, which are keeping pipe dreams alive. However, it's a pretty long and dark looking pipeline.

For now, the algorithms remain focused on lethality headcounts while ignoring what the global economy will look like in a post-apocalyptic COVID-19 world. All the while, experts continue to tell us to ignore the models – even on a favorable daily shift, they're just a black box. Instead, we should look at the elementary numbers.

There are 320m people in the United States. If you assume half will be infected in the next 6-8 months, which is very realistic, about 80% of that 160m will have no symptoms. About 10% will require hospitalization, 5% will need ICU and 1% will die. 1% of 160m is 1.6m people. Markets do not realize that this is long term. In 1918, their pandemic lasted until 1920, and it was only because of "herd immunity" that the virus finally died off. 

Sure, the current level of stimulus is tremendous, but it’s to bridge over "stay-at-home" orders and mandated business closures. It's impossible to draw a lower bound under the economic effects of COVID-19, given the lack of dependable inputs and no historic precedent of this magnitude to correlate the data. 

This week will center on an OPEC+ meeting (Thursday) and Coronavirus evolution activity ahead of the Easter week where we might see a little bit of a slow-down across all assets. 

 

Oil markets

Oil prices pancaked out of the gates this morning as traders remain extremely skeptical a deal will be forthcoming, and that if one does occur it will be woefully insufficient to stem the oil supply gushers. 

Unlike the usual pre-OPEC meeting posturing where Russia typically waffles to get a larger slice of the pie, a barb tossing session turned viciously personal, underscoring the intractability of the stalemate. Putin hates losing face in the court of public opinion, that's a given. 

Also, Russia and Saudi Arabia want the US to join in. Still, US President Donald Trump has so far shown little inclination to comply as word on the street is without US Shale onboard, it’s unlikely OPEC+ will go it alone.

Trump has probably turned less enamored as Moscow continues to drop hints that they would like the US to retract some sanctions, as suggested by the Institute of World Economy and International relations in Moscow. Not only will Trump keep the sanctions in place, but he reportedly now wants to levy more.  

But hope springs eternal

Saudi Arabia, Russia and other large oil producers are hurrying to put a deal together to thwart the epic price crash and, despite the verbal jabs going back and forth from the significant protagonists, as reported, some progress was made on Sunday. 

Even the International Energy Agency is jumping in the middle and calling for action, knowing that if a deal isn't reached it will merely lead to a forced shut-in as storage capacity is saturated.

"We see a huge oversupply in the oil market," Fatih Birol, the head of the IEA, said in an interview on Sunday. "There's a need for the G20 in the driving seat, led by current its current chair, Saudi Arabia."

Why a deal will probably happen

Baker Hughes, on Friday, reported that the number of active US rigs drilling for oil dropped by 62 to 562 this week. That followed a decline of 40 oil rigs the week before. The total active US rig count, meanwhile, also declined by 64 to 664, according to Baker Hughes. Regardless of whether it’s voluntary or forced, US production will come to a halt. And, if willing, the US government would probably be more amenable to cut the industry a bigger bridge loan check. 

To a degree, the oil issue will be stabilized next week; Russian storage issues (very close to capacity) are contributing to a greater willingness to participate in new global coordinated production cuts and Saudi Arabia’s part in the price war was, in part, due to early efforts to dump crude in storage and lease capacity – that all went out the door when COVID-19 demand devastation hit. They might as well be pumping the crude directly into the gulf, given the zero-demand scenario globally.

Even if a deal is reached. 

With the Q2 oversupply estimated at 20-30mb/d, whatever cuts are agreed will not be sufficient to address the near/medium-term oversupply. While a deal buys time and probably averts the worst-case scenario for oil storage being full during Q2 and oil prices falling into the single digits, it still leaves oversupply and warehouse at very high levels globally as headwinds for 2020/21.

 

Gold markets

Gold has traded lower this morning on improving equity market sentiment and as the dollar remains doggedly bid. (More on gold later as I doubt the bounce in equity markets are going to stick.)

 

Currency markets

We know the Euro has little headroom when Europe is in lockdown, but with the Fed trying to hose down the USD wildfire the policy should eventually have a more discernible effect at weakening the dollar. 

Below is a technical reason why the dollar remains in favor beyond the "haven" narrative. 

The EUR/USD and USD/JPY cross-currency bases (XCCY) have improved dramatically (flipping from negative to positive), but the dollar has not weakened.

In theory, Fed rate cuts have eroded the dollar's yield advantage in the G10 space, but the cost of shorting the dollar in the forward market has not fallen by nearly as much. Mainly this is because of money market tensions, which have widened the FX-OIS basis.

Also, the SNB is doggedly defending the 1.05 EURCHF level. While this intervention planked the EURCHF and weakened the Swissy, it may also have been weighing on EUR/USD. With the SNB typically holding at least a third of reserves in US dollars, recycling flows in illiquid markets may help explain why EUR/USD has remained soft. If the SNB buys a billion EURCHF in one fell swoop, the SNB has too many EUR relative to its desired reserve weightings, so the CB sells 300-500 million EURUSD, and the Euro topples 20-30 pips on illiquid markets.

This time, however, the SNB is aware that central banks around the world have thrown the kitchen sink once again, pumping new money into the financial system in an attempt to prevent a liquidity trap. As a result, the opportunity cost of holding Swiss francs as a safe asset has collapsed. But how long are they willing to keep this line in the sand?

 

G-10 FX

The Yen 

Relative rates stay a lot lower – the collapse in US yields has taken the real yield spread to a seven-year low of -0.8%. That points to USD/JPY below 100, but when correlations mean nothing it’s time to go back to the drawing board. Frankly, I have no doubts building JPY longs as there’s no currency more undervalued, relative to risk.

The Loonie

Given the OPEC delay, there’s room for USDCAD to move higher, which could be a home run on a no-deal scenario. I'm long USDCAD as a portfolio hedge (Canadian Assets), not necessarily for a speculative trade, although will flip above 1.50 USDCAD 

 

Asia FX 

The Ringgit 

Lower oil prices point to a softer open for the Ringgit, but perhaps bolstered by a flattening of lethality virus headcounts in COVID-19 epicenters around the globe, suggesting measures like the MCO will see the virus pass quicker and put less pressure on health care resources. 

But prolonged lower oil prices are usually the Ringgit's bullish bet un-winder, so all eyes and ears will be trained on OPEC+ virtual meeting on Thursday.