Charts of the Week: Oil Cuts at Risk, Extreme-Low VIX, and an EZ Inflation Bounce-Back

Summary

• Saudi Arabia’s oil production market share is at multi-decade lows, putting their ‘lollipop’ cuts at risk of an unwind.
• The VIX is at a post-Covid low and supporting credit.
• EZ inflation is returning to the ECB’s forecasted path following the November miss.
• US yields are strongly correlated with the dollar, and we think yields might rise following the QRA.

Market Implications

• We expect brent to settle around $85/bbl by end-Q1 as demand risks should prevent OPEC+ from unwinding cuts.
• We hold both investment-grade and high-yield credit.
• We like fading ECB cuts priced for March or April with an April ECB-dated ESTR payer.
• We are short GBP/USD.

Saudi’s ‘Lollipop’ Cuts at Risk

Saudi Arabia’s oil market share is currently around 8.8% – near all-time lows (Chart 1). This could pressure them to unwind their 1mn b/d ‘lollipop’ production cuts, as it did in the 1970s. While we think Saudi will maintain cuts, we are watching this risk closely. A premature unwind could lead Brent down to $60/bbl.

Credit Finds Support From VIX

Risk assets been taking a breather so far in 2024 – but not credit, where spreads remain on top of December tights. Investors may be holding out on taking profits because they are sanguine about the economic and market outlook in 2024. Credit is also getting support from the VIX, which is trading near pandemic-era lows (Chart 2). We like to hold investment grade and high yield.

ECB to Celebrate Forecast Accuracy

December’s CPI bounced back towards ECB expectations (Chart 3). This did two things. It showed the November miss was a one-off. And it showed the bank’s forecasts are more accurate than expected. Henry thinks they will plug this win at Thursday’s meeting, push back on market pricing of 2024 cuts, and leave rates on hold. We like fading cuts priced for March or April with an April ECB-dated ESTR payer.

Higher US Yields Could Boost USD

In our last FX weekly, we argued risk markets have driven the dollar over the last six months (Chart 4). Although the supply of long-term bonds is already large, term premium on the 10Y is still negative. We are approaching the next Quarterly Refunding Announcement (QRA), where coupon issuance could rise. In the current environment of still negative term premium, this could push long end yields, and so the dollar, higher. That is one reason we are short GBP/USD.

Matthew Tibble is Commissioning Editor at Macro Hive. He has worked as an editorial consultant and freelance editor for companies such as RiskThinking.AI, JDI Research, and FutureScape248.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)