Oil prices rally as Trump administration issues Iran warnings — June crude oil prices on Wednesday rallied sharply by +$2.08 (+3.01%) to $71.14 and posted a new 3-1/2 year nearest-futures high, more than reversing Tuesday’s -2.36% sell-off. After the profit-taking seen on Tuesday, the crude oil market on Wednesday faced up to President Trump’s hawkish speech on Tuesday announcing the U.S. withdrawal from the Iran nuclear agreement and the reinstatement of sanctions.
Crude oil prices on Wednesday were also boosted by the -2.2 million bbl drop in U.S. crude oil inventories in the weekly EIA report, which illustrated a tighter crude oil market than market expectations for a rise of +1.0 million bbls. The report left crude U.S. oil inventories -2.6% below the 5-year seasonal average, just a bit less tight than April’s 9-1/2 year low of -3.3%.
The oil market on Wednesday also took note of U.S. Ambassador to Germany Richard Grenell’s comment that “German companies doing business in Iran should wind down operations immediately.” Under the renewed sanctions, companies are not allowed to enter new contracts with Iran and have 90 to 180 days to wind down existing business. The Trump administration does not seem inclined to grant any significant exemptions from the sanctions. In addition, President Trump yesterday warned of “very severe consequences” if Iran resumes its nuclear enrichment program.
While oil prices rallied on Wednesday, the oil market is not panicking about the U.S. withdrawal from the Iran agreement. There is talk that the Iran sanctions this time around may reduce Iran’s oil exports by only 300,000-400,000 bpd, which would be much less than 1.0-1.5 million bpd during the 2012-15 sanctions regime. The markets believe that some of Iran’s largest customers such as China, India, and Turkey will ignore the sanctions and continue to buy Iranian oil. However, U.S. allies Europe, Japan and South Korea are likely to have no choice but to comply with the sanctions and refuse to buy Iranian oil. Importantly, Saudi Arabia yesterday said it would boost production and cover any supply shortages caused by reduced Iranian oil exports.
Treasury concludes refunding operation with today’s 30-year auction — The Treasury today will conclude this week’s $73 billion refunding operation by selling $17 billion of new 30-year bonds. The $17 billion size of today’s 30year auction is up by $1 billion from Feb’s refunding and up by $2 billion from the $15 billion size seen during most
THURSDAY, MAY 10, 2018
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Iran’s Crude Oil Production mln bpd
Recovery in Iranianoil production following 1980-1988 Iran-Iraq war
Decline in Iranian oil productiondue to sanctions tied to Iran’s nuclear program
Recovery in Iranian oil productionafter sanctions were dropped on the Iran nuclear deal.
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Iran’s Crude Oil Exports
Recovery in Iranianoil exports after sanctions were dropped on the Iran nuclear deal.
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30-yr T-Bond Yield vs 30-yr Breakeven Inflation Expectations
30-yrT-Bond Yield
30-yrBreakeven Inflation Expectations
of 2016-17.
Today’s new 30-year T-bond issue was trading at 3.16% in when-issued trading late yesterday afternoon, which translates to a real yield of 0.97% against the current 30-year breakeven inflation expectations rate of 2.19%. The benchmark 30-year bond yesterday closed +3 bp at 3.16%, which was only 7 bp below February’s 2-3/4 year high of 3.23%. The 30-year bond yield has risen sharply by about 50 bp since last September due to (1) the passage of the tax-cut in December, (2) rising inflation expectations, and (3) expectations for more aggressive Fed rate hikes during 2018-20.
The 12-auction averages for the 30-year are as follows: 2.37 bid cover, $6 million in non-competitive bids, 4.5 bp tail to the median yield, 42.6 bp tail to the low yield, and 39% taken at the high yield. The 30-year is mildly below average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 62.4% of the last twelve 30-year T-bond auctions, which is mildly below the median of 64.6% for all recent coupon auctions.
Yesterday’s 10-year T-note auction saw decent demand with a bid cover ratio of 2.56, mildly above the 12-auction average of 2.43. Indirect bidders took 63.0% of the auction, just slightly below the 12-auction average of 63.1%. The auction yield of 2.995% was slightly below 3.00%, causing the Treasury to assign a coupon to the issue of 2.875%.
Odds for an Italian populist government rise after Berlusconi seems to relent — The odds for a populist government coalition between Five Star and the League rose on Wednesday after Forza Italia leader Berlusconi said that he would not veto a Five Star-League government as long as it adopted policies that are in line with his center-right coalition. Five Star has refused to enter a government that includes Mr. Berlusconi. Five Star and the League asked President Mattarella for another 24 hours to discuss a coalition before he goes ahead with his plan to name a transition government. The markets would not be pleased by a populist government run by Five Star and the League. However, if they are at least anchored by establishment policies supported by Mr. Berlusconi, then the fiscal and anti-EU damage might be contained. At this point, the only other option seems to be another election in July, which could further strengthen the populist parties. The 10-year Italian bond yield spread over the German bund yield has risen fairly sharply by 18 bp to 132 bp in the past three weeks as the Italian political situation deteriorates, although the spread is still at a relatively modest level.
BOE expected to leave policy unchanged — The market consensus is that the Bank of England at its policy meeting today will leave its base rate unchanged at 0.50%. As recently as a month ago, the markets were convinced that the
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Italy vs German 10-year Bond Yields
Italy-German 10-year yield spread (bp) (left scale)
Italian 10-year bond yield (right scale) German 10-year bund yield (right scale)
basis pts
BOE at today’s meeting would raise interest rates by +25 bp to 0.75%. However, the recent UK economic data has been surprisingly weak and the UK CPI in March fell to a 1-year low of +2.5% y/y, causing BOE Governor Mark Carney to recently say that a rate hike in May was far from a certainty. The markets are now discounting only a 60% chance of a rate hike by August. Sterling has dropped sharply by 6% in the past three few weeks due to the expectations for a much less hawkish BOE stance.