Oil: Global macro pivoting around – Deutsche Bank

Alan Ruskin, Macro strategist at Deutsche Bank, suggests that the oil is acting as the main macro driver across all asset classes.

Key Quotes

“It seems almost slavish the way a10y inflation breakeven can follow oil spot prices around, but the current cycle shows persistence in the US 10y breakeven - oil relationship. Break-evens are dominating the rise in yields, notably the US 10y, and higher yields are then spilling over on to the likes of gold. In this way oil and precious metals are currently strongly inversely correlated, and gold is negatively correlated to inflation expectations.

Higher oil prices impact on other risk appetite variables, like equities, is less obvious than it was in Q1. Higher oil prices support capital spending; energy high yield, and energy profitability. As one rule of thumb, an extra $10/b on WTI can add roughly $3 to annual S&P earnings per share. At the same time a sharp move higher in bond yields will negate this positive equity impact. Nonetheless, as long as the backup in long-term rates is contained, over time the correlation between bond yields and equity prices should turn positive again, as distinct from the unusual negative correlation we have seen recently.

For currencies there are potentially multiple trades that fall out of this, or at least reinforce existing recommendations. In G10 and liquid EM land, it plays to long CAD/ZAR, short AUD/CAD, and reinforces comments about the short milk/oil, Kiwi-CAD trade.

Note the recent disappointing CAD performance in the context of oil, might encourage all the above trades to be put on versus the USD rather than CAD, especially when US short-term/policy rates are likely to be much more sensitive to inflation expectations than Canadian short-term rates.

It may not be a pure oil trade, but oil also reinforces one of our favored Blueprint trades, short GBP/NOK.

Note that unlike the big downswing in oil in 2015, where the USD strength was one part of the story, a weaker USD is not a driver of oil higher. In general, the impact on bond yields is not US specific, but to the extent that it impacts Fed policy expectations more than most, higher oil prices will play modestly positive for the USD. On USD/JPY, JPY pairs tend to be notably correlated with inflation break-evens but much of this is about break-evens link to risk-on/off. In current circumstances, USD/JPY is still likely to have a hard time above Y105 given expected local selling interest. As USD/JPY finds support above Y100 it should play to lower USD/JPY vol.

The biggest threat to the above chain of logic is less about changes in correlation/relationship, and more a question of whether we will see oil price increases follow-through? This is not least because a pick-up in non-OPEC supply is widely seen as placing an upside cap on prices near $60/b on WTI. This may limit oil’s longevity as a key driver, but for now it is the single most important macro variable out there.”