Heavy Oil Weighs on Yields and Lifts Yen

The US dollar is narrowly mixed
against the major currencies. 
The drop in oil prices (3.3% this week)
is seen as one of the factors that may be
underpinning the appetite for fixed income, and this,
in turn,
is lifting the yen.  The greenback had approached JPY112
yesterday, but with the drop in oil prices and yields has seen it retreat
toward JPY111.00. 

Sterling has been unable to recover from BOE Governor Carney’s push back
against the MPC hawks.
  Uncertainty spurred by Brexit, and the squeeze
on wages, a key fuel for consumption and growth offsets in what Carney
suggested was the transitory effect of the past decline in sterling.  
Sterling fell below the 100-day moving average yesterday (~$1.2630) for the
first time since mid-April.  The 200-day moving average is seen closer to $1.2555.   The
38.2% of this year’s rally (~$1.2640) had offered support until yesterday and
now may serve as resistance.  The 50% retracement is seen near $1.2520.  

Prime Minister May’s Queen Speech, which opens up a two-year
parliamentary session followed the question time.
  It is rather
aggressive to open the parliamentary session without securing the agreement
with the DUP, even support as a minority
government.     The UK faces several economic and social
challenges, but the self-chosen exit from the EU may prove so distracting and
yet demanding of resources and attention, that little else gets
done.  

The euro is consolidating yesterday’s losses that saw it approach the
late May low near $1.1110.
  This
is seen as the lower end of the
$1.11-$1.13 range that has confined the single currency
for four weeks.  With a light new
stream, the large options that expire today may be important.  At $1.1155,
there is nearly 750 mln euro that roll-off, and another 570 mln with a $1.1180 strike.  Almost a yard
of euros is struck at
$1.12.    Separately, we note a JPY111.30 strike for a little
more than $800 mln also is on the block
today.  

The Australian and Canadian dollars are the weakest of the major
currencies today. 
The RBNZ meeting may
deflect the selling pressure against the
Kiwi.  The Aussie had been in a clear range in recent days (~$0.7570-$0.7635). 
The range was extended to the
downside.  Though new buying emerged near $0.7550, it has made little
headway.  A move above $0.7580 might suggest a false break.  

The Canadian dollar has been chopping broadly sideways after posting
smart gains on the back of last week’s hawkish BoC comments. 
The US
dollar has been largely in a CAD1.32-CAD1.33 range.  It is testing the
upper side of that range today, which also corresponds to a 38.2% retracement
of the greenback’s decline from the June 9 higher near CAD1.3540.   The
50% retracment is found near CAD!.3350.  Tomorrow Canada reports retail
sales and then CPI before the weekend.   Any disappointment could see the
market re-think the likelihood of a hike as early as the July 12 central bank
meeting.

API reported that US oil stocks were drawn down by 2.72 mln barrels in
the weekend ending June 16.
 This
offset the prior week’s unexpected build.  The price of oil price to
seven-month lows before the industry report amid news that Libyan output reaches a four-year high.  The official
government estimate will be reported
today. 

There are three other supply-side stories that weigh on sentiment.
 First, the increase in gasoline inventories (highest since mid-March) at
a time that seasonal factors point to low levels warns that part of the surplus
oil is being moved upstream.

Second, while the rig count has risen for 22 weeks, a record–pace ramp
up, reports suggest that last month 125 more wells were drilled than opened
.
 These wells (DUCs, as in drilled but uncompleted) would generate nearly
100k bpd.  All told, there are
nearly 6000 DUCs, the most in three years.


Third, and under-appreciated, technological progress continues to improve
efficiencies, and drive costs down.
 Some fields in the Permian Basin
reportedly can produce a barrel of shale
oil for $35.  Of course, this is not
the US average production price, but it illustrates what is possible and the
challenge OPEC faces trying to create an
artificial scarcity.  At the end of
the day, the competitive pressures that drive technological advances may be a
more powerful force that collusion among primarily Middle East oil producers
who often have conflicting national interests.

It took a few years, but MSCI finally agreed that China had taken sufficient measures to begin
including the mainland’s A-shares its Emerging Market equity index.
 It
will take place in two steps next year, in May and August.  In weighting
terms, the A-shares will account for 0.5% of the Emerging Market equity index.
   MSCI met China halfway, so to speak. China has made several
reforms to meet MSCI requirement.  MSCI scaled back its proposal and won support by some of the largest
asset managers in the world.

It is an important first step.  Over time, this allocation is
likely to increase, though at some point it could come at the expense of the
other Chinese shares are already included, like H-shares and ADRs. At the same
time, the impact should not be exaggerated.
 The allocation is small enough; some
fund managers may choose to ignore it for
the time being, of buying a proxy in the
H-shares, which have outperformed the A-shares by more than 10 percentage points so far this year.

Bloomberg is overplayed the news by
asserting that it advances President Xi ambition of making the yuan a global
currency.
 Some estimates suggest the 0.5% allocation to A-shares is
worth $8-$10 bln inflows.  Given the
size of the currency market, the average daily yuan flow, it is the minor sum, which
also
is unlikely to have much impact on the prices of local shares.
 At the end of the month, the IMF’s COFER report will show the currency
allocation of reserves as of the end of Q1.  Recall that at the end of
2016, the IMF estimates that the dollar value of the yuan in reserves was a
little less than $85 bln.   From another perspective, China is already a
global currency.  It is in the SDR.  The yuan’s turnover means that
it has surpassed the Mexican peso as the most actively traded emerging market
currency.


Separately, MSCI postponed decisions on whether to lift Argentina from Frontier
to the Emerging Market Index.
 It appears that the decision will be reconsidered next year.  MSCI also
postponed a decision for a stand alone Nigeria equity index until November.
 Saudi Arabia was put on a watch
list for potential inclusion in the Emerging Market Index.  MSCI noted
that Saudi Arabia had taken significant
strides to improve accessibility. 

Chinese shares did edge higher, with the Shanghai Composite gaining 0.5%
and the Shenzhen Composite rising 0.4%.
  Hong Kong’s Hang Seng and an index of China’s H-shares were lower.
  It is not clear how much of the gain in China’s shares can be attributed to the MSCI decision.  The
PBOC is continuing to inject liquidity into the banking system, apparently to
relieve quarter end pressures and that Shanghai Interbank Offered Rate eased
for the fifth day.  Nigerian shares are a little heavy (-0.2%). 
Saudi Arabia’s Tadawul index rallied 4%, recouping this year’s losses. It is
also difficult to ascertain the impact of the MSCI decision and news of that
Deputy Crown Prince Mohammed bid Salman (MBS) has been officially named as heir to the throne.  

The US session features existing home sales.  A small decline is expected.  It would be the first back-to-back
decline since Oct-Nov 2015.  Since October 2106, the monthly report has
alternated between increases and declines.  No Fed officials are on tap,
though three more speak before the weekend.  Lastly, we note that the
Republicans won the two special elections to place Congressmen who have joined
Trump’s cabinet.  Although the Democrat efforts made for tight contests,
and despite the low support rating for the President, the outcome is likely to
bolster the legislative agenda. 

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