All Eyes on Europe +Oil+ FOREX ( EUR & RNBZ new repo facility)

MARKETS

Japan holiday today will sap some liquidity from Asian trade today, and US cash treasuries will be closed in the region.

US equities were stronger Friday, S&P up 1.9% on better US data, closing the week 0.9% lower. US 10yr yields finished down 4bps to 2.92% and 17bps for the week. Oil closed up 2.1% and back above USD100/bbl for now.

Overall the robust US data on Friday eased concerns about an imminent recession but is also unlikely to mount an additional case for a 100 bp Fed hike. And it was about as goldilocks of a mix of headline data risk as one could have expected given the FED’s dilemma of balancing Inflation vs Growth. Especially as stubbornly high inflation could lead to the FED overshooting and market pricing in a much higher risk of recession. But the decline in US long-term inflation expectations and less hawkish Fed speak on Friday helped temper the pricing of aggressive hikes and helped US equities close higher.

OIL

OIl is opening the week softer as the market digests the demand impact of the rise in new Covid cases in China and as the market cautiously awaits the monumental event risk if Nordstream 1 gas flow from Russia to Europe will resume later this week.

The OPEC+ quota system ends in September, and attention is turning to what will happen next.

As long as the agreement is in effect, Saudi Arabia has made it transparent that individual producers with spare capacity should not exceed their quota to offset underproduction elsewhere within the group.

From October, however, this changes. Nigeria, Libya, Venezuela, Iran, and Ecuador are all struggling to meet their quotas, while Saudi, Iraq, Kuwait and the UAE have 2mb/d of spare capacity.

In addition, Venezuela could add 1.25mb within a year if US sanctions ease, according to our recent expert call, and Iran is ~700kb/d below pre-agreement production and ~1.3mb/d below stated capacity.

As the market reprices a delayed reopening in China and potentially more barrels coming back to the market in October, oil could struggle to make new highs. And It could crash later this week if the gas flow from Nordstream1 doesn’t return, which would undoubtedly tip Europe into a deep recession.

FOREX

After hitting parity for the first time since 2002, the Euro faces several critical tests in the week ahead—the first ECB hike in over a decade along with an anti-fragmentation backstop tool, a potential further interruption to Russian gas flows, and now the risk of an early election in Italy.

And while an ECB rate hike and rolling out an anti-fragmentation too could temporarily stabilize the EURO near the recent low end of the trading range, the prospect of a prolonged gas flow disruption is likely to hang over the Euro-like a storm could throughout the week. But, even in the markets baseline scenario that gas flows will partially return (to about 40% of normal), it is crucial to keep in mind that anything less than 100% will almost certainly require either higher prices pushed on to the consumer or government rationing—in parts of Europe, likely leading to a recession in Germany and Italy.

New Standing Repo Facility From RBNZ

The Reserve Bank of New Zealand announced a standing repo facility Monday morning after funding via FX forwards crashed in April and May as the domestics chased USD. The repo facility will help to prevent this by allowing eligible counterparties to lend NZ overnight and TN at 15bp below the official cash rate (OCR).

Offshore banks will then have a mechanism for lending NZD surplus, given these banks generally run USD surplus. This should help anchor the front-end FX forwards as it provides more liquidity when the system balance remains above 50 bn and should be more beneficial to offshore banks looking to lend out surplus NZD better than the FX forward implied.