Oil Update

Analysis: Oil prices are rebounding this morning amid optimism that the US will eventually reach a new debt deal. This has crude on track for its first weekly gain in a month, with Brent futures trading just below $76.50 per barrel. Buying of physical crude by Asia refiners added to the bullish tone as we enter the final sessions for the week. Oil refiners in South Korea and Taiwan bought at least 14mn barrels, according to traders. This is marginally higher than the average and will come as a bit of relief to the market, as demand for physical crude has looked weak in recent weeks. Asian refining margins, however, are still well below levels seen earlier this year, and we may need to see these pick up for demand in the region to recover and boost crude prices further. Meanwhile, we could see oil track risk sentiment into the weekend, leaving US debt ceiling discussions as the likely main driver of prices in the short term. Any further optimism regarding a deal could see Brent rise back to its highs from earlier this week near $77.30 per barrel. 

While the ZAR continues to hover near the depths it plumbed against the USD, EUR, and GBP last week, it has pulled back slightly. The market has thus far been reluctant to sell the ZAR at weaker levels than those reached last week, suggesting that a degree of uncertainty has left the market after the damage control done by the government last weekend. Moreover, the improbability of grid collapse during the winter is now better understood, and although it remains an extreme tail risk, it has likely been priced out to some degree this week.

Still, risks remain. After today’s close, ratings agency S&P Global is scheduled to provide a credit rating update on SA. With SA’s growth outlook deteriorating notably in recent months, and broader optics also extremely poor at the moment, there is a chance that S&P’s outlook on its BB- rating for SA changes from stable to negative. Alternatively, the agency may wait for more information concerning public sector wage increases and whether SA opts to make use of Karpowership’s floating power plants to support Eskom’s generation capacity.

On that front, news broke yesterday that the Turkish company secured government permission to moor its ship-mounted power plants at three of South Africa’s harbours. While there are still some hurdles for the company to clear, it appears there is a strong push from government’s side to make use of its services. The clear benefit of this would be increased electricity supply at a time when talk of potential grid collapse has become part of household conversation. As for the negatives, the Zondo Commission has taught us that there is significant risk of rent-seeking behaviour in such large deals; the ships will be far from good for the environment; and, perhaps most importantly, the ships will come with large price tags and longer-lasting contracts than SA needs them for. However, given the significant risks around Eskom’s inability to meet electricity demand at the moment, it might be an easy choice for government to make.

While the ZAR has drifted back towards the lows it reached against the majors last week, it is trading on the front foot this morning. The global market’s focus is fixed on Stateside debt ceiling talks, and the most recent reports suggest that there has been some progress towards a deal. This is positive for market sentiment, but also for the USD. That the ZAR has been able to recover against a stronger greenback in this context speaks to a market that is reluctant to trade much weaker without a fresh catalyst. This may come in the form of S&P’s credit rating review this evening, although barring a negative outcome, the balance of risks does appear to be tilting back towards ZAR consolidation and perhaps even recovery over the near term.

Bonds/Yield Curve: US 10yr treasury yields have nudged higher throughout the week and are trading back towards highs last seen in March. Some resilient US economic data and optimism about a debt-ceiling deal being reached will support yields a little longer, although it is interesting to see how the US yield curve has flattened slightly. For SA bond yields, this keeps the pressure on and again tilts the scales in favour of the SARB taking a bolder decision to hike rates by 50bp. Should this evening’s S&P review deal the ZAR another blow, the decision will be obvious for the SARB, which is still tasked with protecting the value of the ZAR and ensuring price stability.

But the hits keep coming for SA, and the country’s risk profile has deteriorated. An S&P rating shift to a negative outlook may change little but serves to highlight the plight of ordinary South Africans dealing with the fallout of a badly run government and the inability to resolve Eskom’s or some of the other SOEs problems. Tax revenues are not as strong as anticipated, and intensifying load-shedding conditions will only exacerbate that. Add to that the depreciation in the ZAR, and inflation also takes a knock.

Today’s ILB auction will attest to that, with breakeven rates likely to reflect the shifting expectation that inflation may remain more elevated for longer. This just goes to highlight another battle that the SARB has yet to overcome. Today will see National Treasury auction off the I2029, the I2033 and the I2038 and should breakeven rates rise from last week, the SARB will struggle not to hike rates by 50bp or even more.

FRAs: Meanwhile, FRA rates have continued to shift higher. Investors are not just pricing in the risk of 50bp, but the SARB could even do more. The 6X9, in particular, now trades closer to 9.14% and suggests that more than 125bp worth of hikes are priced in before the SARB tops out. This is a substantial departure from what the market was pricing in just three weeks ago and reflects the severe deterioration in expectations for the ZAR and inflation. Equally notable is how the longer-dated FRAs have risen even more sharply than the short end, with the spread of the 9X12 and 12X16 to the 1X4 rising to 60bp and 49bp, respectively, implying that rates will also be higher for longer, although they will start to decline towards the middle of 2024. This reflects a sharp shift in sentiment towards SA, and the SARB will need to respond, lest it allows this sentiment to intensify and makes meeting their inflation mandate that much tougher.

Repo: It is likely that the SARB will hike by a minimum of 50bp at the next meeting to stabilise markets. This is not what forecasters or the SARB had in mind, but there was panic in the market last week, and bold decisions are needed. Any expectations of rate cuts early in 2024 have now disappeared, and all eyes will be on whether the ZAR makes a full recovery or not. The ZAR is vulnerable, which may even prompt the SARB to remain hawkish, although an intra-meeting emergency hike is no longer looking as necessary. The peak in interest rates priced into FRAs has now moved 100-125bp higher but could stabilise around current levels ahead of the SARB decision and statement next week.

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