OPEC deal supports higher price of oil and weaker yen - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the yen has weakened further following the announcement yesterday that OPEC members have reached a final agreement to significantly cut production lifting USD/JPY to an intra-day high overnight of 114.83.

Key Quotes

“The final OPEC agreement has helped the price of oil to regain upward momentum lifting it back above USD50/barrel. OPEC members reached an agreement to cut production to 32.5 million barrels/day during the first half of next year which was towards the upper end of guidance provided in their tentative agreement set out in September. In addition, non-OPEC members have committed to cut production by 600k barrels/day if OPEC members fully comply with their own production targets.”

“In light of the deal we will be adjusting out forecasts for the price of oil and related currencies modestly higher in the release today of our latest monthly FX Outlook report. We had already been assuming that OPEC would reach an agreement. It supports our view that the price of oil will continue to rebound towards USD60/ barrel next year. OPEC’s shift in strategy to cut production highlights that they were concerned that without intervention supply and demand conditions would have resulted in the price of oil remaining lower for longer. Amongst oil related currencies, we continue to expect the Russian rouble and Norwegian krone to outperform as both currencies should prove less sensitive to higher US interest rates.”

“However, the rise of US shale oil production has dampened the ability of OPEC members to influence the price of oil. A higher price of oil will encourage US shale oil producers to rebuild production dampening upward pressure on prices from the OPEC agreement. As a result, we expect only a modest rebound in the price of oil and related currencies in the year ahead. There is also the risk that the OPEC agreement will not be fully implemented leading to a smaller production cut which would dampen support for the price of oil.”

“One potential spill-over impact from the higher price of oil could be that it reinforces Trump reflation trades. Tighter supply combined with stronger demand if President Trump’s policies help to boost US and global growth would increase upside risks for inflation. The Fed is likely to be under even more pressure to speed up the pace of rate hikes in the coming years supporting a stronger US dollar. The US economy would also benefit from the higher price of oil as it will encourage a rebound in capital investment in the year ahead especially in the energy sector.”

“In contrast, the OPEC agreement is another bearish development for global bond markets and the yen which will be undermined by the higher price of oil and overseas yields. The higher price of oil will increase upward pressure on the BoJ’s target to keep the 10-year JGB yield at around 0% which could require a faster pace of purchases. The BoJ will welcome a higher price of oil as it will help lift headline inflation and encourage a pick-up in domestic inflation expectations.”