USD: Through the Lockhart Glass

A potential September rate hike still hangs over the markets like a Sword of Damocles.

Source: Bloomberg

After supportive comments from FOMC members James Bullard and Dennis Lockhart recently, voting member Jerome Powell said “nothing has been decided” in an interview overnight.

The US ADP employment number also undershot consensus forecasts and was down 20% year-on-year. This saw US 2-year treasury yields climb 8 basis points; however the market is still pricing in the probability of rate hikes in September at 50%. The dollar index declined 0.3% at one point, but much of that drop was pared back and the USD is now steadily appreciating against most major currency pairs.

The oil market is still very focussed on further US dollar rate rises. Brent crude hit new six-year lows, dropping below the key psychological $50 level again to $49.59. WTI also declined 1.3% and is getting close to testing the $45 dollar level (currently $45.15).

This is not only a strong US dollar story. Global oil markets are still massively oversupplied at the moment, with US crude inventories increasing again to 100 million barrels above the five-year average. Brent contango has increased to its widest margin since February on the expectation of further build ups in crude inventories in Q4. Iran oil minister, Bijan Namdar Zanganeh, announced recently that Iran expects to be producing 4 million barrels a day within 7 months.

In preparation, Saudi Arabia and Iraq have been producing at record levels. Their theory is that pushing the price down further will not only stimulate demand growth but also push the non-OPEC and non-shale producers out of market, allowing space for the market to absorb all the potential new Iranian supply. If this continues, anyone hoping for a quick bounce back in oil prices in the second half of the year is going to be severely disappointed.

The ASX at the open

The biggest news on the ASX today is clearly Rio Tinto’s earnings report. The market will be looking intently at RIO’s ability to continue its expenditure cutting. RIO previously set its cost-cutting target at USD $750 million, and any further increases to this would be most welcomed by investors.

The consensus is for RIO’s EPS to come in at 1.273 and for total revenues to reach $18.7 billion.

There will also be a keen focus on RIO’s iron ore output and its ability to continue further growth.

Iron ore prices have climbed over 10% since their 8 July low. Poor economic data out of China have increased prospects for a major stimulus package in 2H. China’s push to create new mega-cities, refurbish shanty-towns and their ambitious plans for the new Asian Infrastructure Investment Bank and the Silk Road Fund are all laying the groundwork for potential greater iron ore demand.

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