Oil prices down over 6% as Saudi production back up. USD reverses course, seeing NZD and AUD recover yesterday’s losses. UST yields lower

Oil prices have reversed course after it looks like Saudi oil production will be fully restored by the end of the month. The NZD and AUD have recovered losses seen during local trading, while EUR and GBP have reversed losses seen earlier this week. US equities are flat, while US Treasury yields are lower.

Brent crude is down over 6% for the day to USD64.50 per barrel, with prices falling after Reuters reported that lost Saudi Arabia oil production is close to being 70% restored and that production will be fully back online in the next two to three weeks. This was later confirmed, with Saudi’s oil minister saying that just under half of lost oil production has returned to the market and production will be 11m barrels per day by the end of September, its pre-attack level.

So while it looks like oil production will be restored earlier than feared and the oil market will return to balance quite quickly, some sort of higher oil risk premium is likely to be sustained, given the evident vulnerability to supplies and as we await the US response to the attacks.  CBS news reported that the US has identified the exact locations in southern Iran from which more than 20 drones and cruise missiles were launched against the Saudi oil facilities. Over to you, Mr Trump, for your orders.

US second-tier economic data came in stronger than market expectations, with US homebuilder sentiment up to an 11-month high, supported by mortgage rates running at 3-year lows. Industrial production was stronger in August, although supported by some one-off factors, with leading indicators pointing to recessionary-like conditions in that sector, not helped by the trade war. The data had little impact on the market.

In currency markets, the USD has come under some pressure, reversing a lot of its post-attack gains earlier in the week, with the EUR and GBP the main beneficiaries – up 0.6% to 1.1070 and 1.2510 respectively.

The AUD was weaker yesterday, with the RBA minutes of the September meeting seen to be more dovish than expected. The key policy paragraph dropped reference to waiting for an “accumulation” of evidence in deciding to cut rates again, seen to lower the hurdle for another rate cut. The statement also conveyed a more cautious global and domestic economic outlook. We continue to expect another 25bps rate cut in November, but the labour market report Thursday could tip the balance to October if it comes in much weaker than expected. The AUD fell 30pips or so to 0.6830, but has since recovered to trade at 0.6860, helped by a weaker USD.

The NZD fell in sympathy but found some support just below 0.6325 and is back up through 0.6350 this morning. The NZD/AUD cross rate is hovering around 0.9250, with the dovish RBA minutes alleviating some of the hitherto downward pressure.  The GDT dairy auction price index rose by 2.0%, more in less in line with expectations for a mildly positive result. Prices were higher across most product lines, including a 1.9% gain for whole milk powder. The gain in prices after three negative auctions should solidify expectations for the current season milk payout.

Despite the more positive news on Saudi oil production, US Treasury yields haven’t reversed course and downside pressure has remained, seeing the 10-year rate trade this morning at 1.81%, down 4bps for the day and a couple of bps lower since the NZ close. There has been a fair amount of dislocation in US money markets this week. The New York Fed was forced into conducting its first overnight system repurchase agreement in a decade after a surge in USD funding rates that rose as high as 10%. After offering $75b, some $53b was injected into the market. Problems in US short-term funding markets have been brewing recently, given the surge in US Treasury bonds and bills issuance and a lack of excess bank reserves, putting upward pressure on the important Fed Funds rate. Some experts suggest it points to a structural flaw in the market and a more permanent solution will need to be found, otherwise these operations will become more frequent.

Yesterday, the NZ government launched its syndication of a new May 2031 nominal bond, capped at $2bn. But the prevailing force on NZ rates was the downdraft in global yields, seeing government rates close 5-6bps lower across the curve, with similar moves in longer term swap rates.

Trading activity is expected to be light ahead of the Fed’s policy update at 6am tomorrow NZ time. A 25bps rate cut is well priced, taking the range down to 1.75-2.0%. The focus will turn to the language used by Fed Chair Powell. As in his Jackson Hole speech, we expect language around “trade uncertainty” to get widespread airing and the path of monetary policy from here shouldn’t be locked down too hard, with an easing bias likely to clearly remain in force. The dotplot of the projected Fed Funds rate is expected to show at least one more 25bps cut, probably before year-end, well short of current market pricing which shows another 1½ rate cuts through next year.