Mizuho Daily – Down, But Not Under

Mizuho daily insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Down, But Not Under

RBA meeting Down Under turned out to be a mixed bag of reactions. The lack of fresh policy action was widely anticipated. But reference to ramped-up bond buying to help keep yields Down (amid UST yield volatility) as brought forward, rather than enlarged, QE Under-whelmed. AUD though was on a stronger footing above 0.78 as markets focused on RBA allusion to AUD still being undervalued vis-a-vis commodities rather than being fairly elevated. In other words, the RBA’s suggestion that AUD is “Under” not “Down” was ignored; and today’s Aussie GDP may buoy AUD too.

Australia extended sequential growth pick-up as Q4 GDP rose 3.1% QoQ, with commodities acting as a key pillar to supply-side boost to activity. Although pace of recovery was Down from 3.4% in Q3, this reflects exceptional base effect boost fading and not Under-mined improvement. The big picture is that while the initial recovery through H1 2021 may still be subject to air-pockets and jobs vulnerabilities linger (merely masked by fiscal support), Australia is unambiguously on a surer path to sustained recovery. Especially as the reflation boost to commodities add to tailwinds. Against this improving growth prospects, the RBA’s policy hold is validated; as is its market vigilance on bond yield volatility.

Elsewhere, UST yields and US equities were also Down, but not Under undue stress. Equities were prone to profit-taking after the rebound the day earlier, while Fed Brainard expressing concern about the speed and depth of recent UST yield surge eased 10Y yields slightly to 1.4%. USD was Down on softer yields and some calm; and so while softer is not Under seige. EUR pick-up towards 1.21 was not fully matched by USD/JPY easing (still aboe mid-106) and USD/SGD near 1.33. Finally ahead of tomorrow’s OPEC+ meet Oil is Down a tad, but not Under threat from supply shocks.

OPEC+: Phased, Not Fazed

As the OPEC+ gets set to meet for March (4th), all eyes will be on how much, not whether, the OPEC+ will restore production; in response to a strong rebound in Oil since November (with Brent up from sub-$40 end-October to $60-65 currently. But restoration is set be phased, unhurried by demand recovery prospects from vaccinations, and certainly unfazed by dangers of Oil price overshoot dampening demand recovery.

For one, the upswing in prices has been from very weak levels. Second, the OPEC+, and especially Saudi, remains wary of a bumpy and uneven recovery at least through H1 even with vaccine rollout. Crucially, a supply glut in inventories will probably persist into Q3 (albeit greatly diminished), even with a phased rollback of curbs. So a one-off restoration risk undoing all of OPEC+ efforts. For the record: OPEC+ output cuts, gradually reduced from 9.7MBpD record cut in Apr 2020, stand ~7MBpD; and Saudi has unilaterally implemented another 1MBpD cut for Feb and March.

So the question for April is two-fold. First, whether OPEC+ will collectively relax output curbs by another 500KBpD. Second, how quickly Saudi will phase out its additional 1MBpD output cut. It is highly unlikely that Saudi will instantaneously start the pump on the 1MBpD. More likely, a phase restoration over Q2; so that markets are not fazed! Especially given that Oil prices slipping ahead of OPEC+ meet, presumably in anticipation of some degree of supply restoration, warns of lingering fragilities in Oil’s recovery.

The wider, and arguably more interesting, dynamic are growing divergence within OPEC+. Notably, the tension between Saudi, which prefers a more cautious (and hence more calibrated) phasing out of curbs and Russia, which prefers to restore production sooner. To what degree this reflects Russia’s more aggressive strategic positioning against US Shale producers, seen to be hitching a ride on OPEC+ curbs and resultant price increase; and how much of it merely reflects financial strains is unclear; and in all likelihood will continue to evolve. For now though, we expect that OPEC+ phased approach to supply restoration will not faze Oil markets to the degree that (Brent) Oil prices durably fall below the $58-68 range.

Source: Mizuho Bank Ltd