In today's market update, Oil futures are offered this morning as we head into the final trading sessions of the week. The Brent front-month contract is trading back near $72.25 per barrel, while WTI has slipped back below the $70 handle.
5 reading min
11 Jun 2021
Analysis: Oil futures are offered this morning as we head into the final trading sessions of the week. The Brent front-month contract is trading back near $72.25 per barrel, while WTI has slipped back below the $70 handle. Both are still on track for a weekly gain, however, with WTI outperforming as it has risen almost 2% on the week so far. The demand outlook remains very supportive of the market at the moment, but how much further prices can go remains to be seen given that most of the good news is priced in already. Oil bulls seem not to be worrying about any further increases in supply, either from Iran or OPEC, until they actually materialise. However, questions remain over the demand outlook in Asia. Reports suggest that there is a notable amount of crude sitting in offshore storage. At such price levels, storing doesn’t make sense, so it points to limited demand at the moment. Once Asian demand returns to levels seen before the pandemic, supply could be notably higher to prevent any further leg up for prices.
The local currency was on a tear yesterday as the ZAR bulls looked to recoup the previous day’s losses, which put the unit at a one-week low against the USD. Further aiding the ZAR, the USD failed to catch a tailwind from inflation data which showed CPI rose 5.0% y/y in May, up from a previous reading of 4.2%, despite US Treasury yields lifting initially to account for the faster-than-expected annual inflation. Nevertheless, the dollar fell on a trade-weighted basis alongside Treasury yields later in the session as the market remained unconvinced these price pressures will result in runaway inflation. To that point, inflation slowed on a monthly basis from the April print.
The ZAR took this in its stride later in afternoon trade, adding to gains secured earlier in the morning. On the domestic data front, the current account surplus widened more than expected in Q1, coming in at 5% of GDP or R267 billion from a prior figure of 3.7% of GDP or R198 billion. A breakdown of the data from the SARB shows that South Africa’s trade surplus widened from R425 billion in Q4 of 2020 to R430 billion. The larger trade surplus resulted from the value of merchandise exports increasing to a new all-time high while imports rose to a lesser extent.
High commodity prices continue to drive exports, underpinning a large trade surplus while imports remained subdued due to a weak economic recovery. With these dynamics set to stay, at least in the near term, SA’s trade account and, by extension, the current account will remain supported and thus continue to underpin the ZAR’s resilience.
The big news in the session yesterday was the significant loosening of red tape around independent power production. Ending Eskom's monopoly power is one of the significant structural reforms needed. It will be a green light to investors, although how much capital it attracts is still an open question given the debasement of the economy through the past decade. A government characterised by a decade of malfeasance, corruption and ineptitude has driven credit rating downgrades and a massive build-up in debt. SA no longer holds the attraction it once did.
Ramaphosa reported that the independent power production plant limit would be increased 100-fold from 1MW to 100MW, which is enough power for over 16k homes. Estimates suggest that this could substantially increase the total power available to the grid, with The Minerals Council of SA highlighting that this opens the door to around 1.6GW of green energy production from IPPs. "This has the potential to raise SA's overall growth rate. What is needed as a next step is to develop concrete plans to shorten the grid-tie licensing process with Eskom and to expedite environmental authorisations without compromising their integrity," the council said in a statement. For comparison, Eskom's current capacity shortfall last night was at 1.4 GW. If achieved, an IPP rollout will significantly alleviate the electricity shortfalls in the economy, but the question remains of whether implementation will be as simple as the announcement was. The announcement implies a significant change to the overall associated regulations. Whether the government can sufficiently loosen decades of monopoly-aligned public policy without causing more headaches is yet to be seen.
The market seems to be enjoying the news with SAGBs continuing their bull run, with the front end notably finding much support. The credit default swap market, which prices government default risk, has also reduced its overall level of risk. The 5y CDS has fallen to 180bp from May highs of 222bp. Given the continued rally in vanilla SAGBs, too, this broadly suggests that fiscal sentiment is improving. Concrete reform steps are something that the rating agencies will smile on.
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