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FX & Commodities

May 2024

Positive on gold

We remain positive on gold, which is an effective portfolio diversifier amidst favourable drivers, such as central bank buying, US fiscal sustainability fears and anticipated rate cuts later in the year.

Vasu Menon
Managing Director,
Investment Strategy,
Wealth Management Singapore,
OCBC Bank

Oil

Elevated OPEC+ spare production capacity should help limit the risk of a sustained break of Brent oil over US$100/barrel (bbl). OPEC recently reiterated its supply policy, with recent production cuts extended until the end of June. However, that leaves it with approximately 6 million barrel per day of spare capacity. OPEC+ could gradually raise production in 3Q2024 given current high spare capacity, which in turn could cool the oil market. The probability of production increases by OPEC+ will likely rise further if supply were disrupted elsewhere.

Our base case is for tensions to remain high in the Middle East but stop short of meaningful escalation. The muted reaction by Iran to the measured nature of Israel’s response to direct attack by Iran suggests that the risk of conflict escalation remains in check, at least for now. We kept our 3-month Brent forecast unchanged at US$89/bbl. But higher geopolitical risk does mean that oil prices will stay high for longer and may be slower to ease off in response to growing non-OPEC supply. We have lifted our 12-month Brent oil forecast to US$80/bbl from US$75/bbl.

Gold

Robust portfolio construction and diversification represent the first line of defense for investors worried about geopolitics. As a proxy for safety, gold is most valuable in periods of prolonged geopolitical uncertainty. Our broad view of gold coming into this year has been constructive, and the hedging value for geopolitical risk has been an important part of that case.

Besides being a reliable hedge against negative geopolitical shocks, gold could enjoy further tailwinds once the Federal Reserve rate cut cycle gets going. We have lifted the 12-month gold price target to US$2,500/ounce. We expect the Fed to start cutting rates in 3Q2024 and see two cuts this year.

There are structural shifts in demand that will support gold, independent of the macro backdrop. First, central banks in Emerging Markets have stepped up gold buying after the US weaponised the US Dollar in its sanctions against Russia for its invasion of Ukraine in 2022. Second, retail gold buying in China has increased as returns from property and stock market investments disappoint, and deposit rates remain low. Third, renewed focus on fiscal deficits and rising debt-to-GDP ratios in the US ahead of the Presidential elections in November can be seen as another feature of brewing structural fear with a positive influence on gold.

Currency

The US Dollar (USD) Index (DXY) closed 1.7% higher for the month of April. Stronger-than-expected US payrolls and inflation reports led to another round of hawkish repricing for the Fed funds rate in future. As of 30 April, markets have pushed back the timing of the first US Federal Reserve (Fed) rate cut to November 2024 (from July previously) and for the year, a cumulative 35 basis points (bps) of cuts versus 67bps expected a month earlier.

The divergence in US inflation versus the rest of the world, including Europe, Switzerland, Canada and China has also resulted in a deepening of Fed policy divergence versus other central banks including the European Central Bank (ECB), Swiss National Bank (SNB), Bank of Canada (BOC) and the Chinese central bank (PBOC). This is also adding to USD strength. Given the USD’s yield advantage and the US exceptionalism narrative, the USD may continue to stay supported until US data starts to show more signs of softening or when the Fed’s hawkish rhetoric softens. For the year, we still expect the USD to trend slightly lower towards year-end once the Fed is done tightening and embarks on a rate-cut cycle in time.

The Euro (EUR) partially reversed early-month losses in April after data supported the view that growth conditions in the Euro-area and Germany may be showing signs of stabilisation. Elsewhere, geopolitical tensions in the Middle East eased somewhat, which benefits the energy-dependent Euro-area. Comments from various ECB officials have pointed to a June rate cut, but the rate path trajectory beyond that remains uncertain. As of 29 April, markets have largely priced in a first rate-cut occurring at the ECB’s next policy meeting on 6 June, and for the year, markets priced in three rate cuts. While markets may have largely priced in ECB rate-cuts into the EUR, a re-rating of the growth outlook for the Euro-area economy is probably not priced in. And lately, there are signs to suggest a stabilisation in the Euro-area’s growth. ECB’s Lagarde and the Bundesbank have recently spoken about signs of activity gathering pace in Germany. A better growth story for the Euro-area means that aggressive rate-cut expectations from the ECB could see a pushback – which is supportive of the EUR.

The USD-Japanese Yen (USDJPY) cross rate has been more choppy than usual recently. Price action has also spurred market chatter of JPY intervention. There was no confirmation as top currency official Masato Kanda declined to say if the authorities intervened. But initial estimates based on the Bank of Japan’s (BOJ’s) daily reporting of current balances suggested intervention of about Y5.5tn on 29 April. Given the still wide gap between US Treasury yields and Japanese Government Bond yields amid Fed-BOJ policy divergence, dips in the USDJPY may still find support. A combination of the BOJ demonstrating urgency to normalise policy and the Ministry of Finance (MOF) conducting currency intervention may perhaps be more effective than the MOF doing a solo. Of course, a less strong USD will be helpful to the JPY. This will be dependent on US data. Near term, we still do not rule out two-way swings as markets may make another attempt to test the JPY. But we reckon that the authorities should at least attempt to limit the high (i.e. lower the highs to ensure that intervention efforts are not wasted). Over the medium term, we expect USDJPY to trend gradually lower on expectations that the next move from the Fed is a rate-cut and that the BOJ has room to further pursue policy normalisation amid higher services inflation and wage pressures in Japan.

The combination of high for longer interest rates in the US, geopolitical risks, and renewed volatility in the Chinese Renminbi (RMB) and JPY may impact most Asian currencies in the near term. In particular, the Asian currencies that are highly sensitive to energy prices, yield and China factors are the Korean Won (KRW), Taiwanese Dollar (TWD), JPY and Thai Baht (THB). That said, policymakers in the region are also seen taking a more proactive stance in smoothing out the one-sided moves. On 18 April, there was confirmation of a G7 statement on currencies, a joint statement issued by the finance ministers of Japan, Korea and the US on currencies, along with the PBOC commenting on the RMB. It may not be akin to the 1985 Plaza Accord, but a G7 statement commenting on currency moves may be good enough to setup a psychological resistance for USD. It was not just the G7, but the PBOC and Bank of Korea (BOK) amongst regional central banks weighing in (it felt like coordinated verbal intervention). This should provide an extended breather for some of the worst-hit regional currencies such as KRW and JPY, and calm sentiment towards the RMB. This will also help to support the MYR. The last time the G7 warned against currency volatility was on 12 October 2022, it coincided with a peak for the USD then.

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