After almost hitting 30 dollars a barrel in both WTI and Brent yesterday European morning time we seemed to be in for some kind of short-covering reprieve, albeit small and only taking us back to the 32 handle. It didn’t last long. During the following US session WTI finally dipped below 30, and the little bounce had evaporated quickly. The question remains how far down is this going to go, and how long will it last? To be sure, we can talk about lagging demand and increasing supply until the cows come home, but we have better and timing-wise more precise indicators than that.
EM currencies, and those ones linked to commodities and particularly oil and gas, have been useful harbingers of things to come. And this picture doesn’t look all too pretty. Most prominently, the Russian Ruble has maintained one of the most precise correlations with the oil price in dollars – R squared is 0.92! As commented previously, Russia will do its bit to keep the country’s Ruble-denominated income from oil sales constant or by way of higher volumes even larger than when oil traded at 100. The resulting inflation they have inevitably incurred down the line may be displeasing but is being viewed as collateral damage.
The recent drop of the Ruble, first breaking the 70 mark and then 75 at the market re-opened after the Orthodox holidays, is already giving us a hint that the oil show isn’t over yet. The current momentum could easily carry the currency to new all-time lows of between 80-85, which according to the correlation would certainly translate into an oil price in the 20s, maybe even low 20s. So there we have it. It may not happen after all, but if one was a betting man, one better not go against the market forces at work.
The former Soviet satellite states, Kazakhstan and Azerbaijan, with their respective currencies Tenge and Manat, are equally suffering and harbingering. The Tenge de-pegged in August and has lost over 30% of its value since then. The Azeri central bank broke its dollar peg just before Christmas and had the Manat re-marked almost 50% lower. There has been quite some catching up by Central Asia with Russia, a currency divergence that could not have held for much longer in light of their economies still being massively intertwined.
I commented on the other resource monies and their slide a few days ago. Everything has gone lower since, with Aussie weakening more and Canadian dollar at new lows. The SA Rand basically gave up, also for political reasons, hitting another all-time low of 17. The Malaysian Ringgit has not broken yet, like the Ruble, but it has developed the same momentum and at 4.40 is just on the cusp of leaping to potentially 5. The Brazilian Real commands the same pattern easily re-capturing the 4 threshold.
Perplexing also how the Mexican Peso got a beating recently and made new lows, from 13 as recently as 2014 to 18 at the start of the week. Perplexing because Mexico has its house in absolute order. The economy is growing decently, the fiscal deficit is actually Maastricht material, and inflation at 2.5% is below central bank target and a dream scenario for the Western world. They even captured El Chapo. The only EM currency out there that is surprisingly resilient is the Indonesian Rupiah. Inflation is low, and rates are rather on the way down than anything else.
Now what about the rest of the remaining pegs out there? The Riyal peg is understandably stressed, even though the Saudi Monetary Authority was busy playing it down last night. But the lower oil goes, the higher the probability that the Saudis will have to let it go. In the bind they are in, i.e. oil output close to the maximum, tensions with Iran on the rise and a budget deficit of 20+% killing currency reserves, their hand may well be forced in due course. Whether for the right reasons or not, but a de-peg would beat crude prices even further down, at least in the short run.
It may also be the very last straw for everyone else who are still holding the fortress but awaiting the domino effect. UAE’s Dirham would inevitably be next, as would be the Qatari Riyal. Omani Rial same. The Kuwaiti Dinar has already been floated to some extent in 2015 but would equally be sucked into the mincer. The IMF is already pleading with the Nigerian central bank to give in. So far, the official Naira exchange rate is holding below 200, just. The black market however already prices in a 25% revaluation, like in 2008 and 2014, due to the massive dollar shortage.
The world has turned into a pressure cooker and needs an outlet – it has found the currency markets. Remember the movie Gladiator, when in the closing scene fellow slave Juba buries Maximus’ hand-carved wooden figures resembling his slain family and stammers: I will see you again, but not yet… not yet. The world will see a weakening dollar again, and it will see rising oil- and commodity prices again, but not yet… not yet. The Fed will first have to come to its senses and a monetary u-turn be in sight, before Juba gets to see Maximus in the other world. Until then, beware.
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