- Oil sales still capped under initial Iran deal but attempt for comprehensive solution in six months
- Our base scenario is that Brent oil will drop to average USD 95 per barrel in 2014
- On the currency markets: Dollar’s correlation with US Treasury yields rises
Initial ‘understandings’ on Iran’s nuclear programme
The so-called P5+1 group of countries (the US, the UK, Germany, France, Russia and China, as well as the European Union) reached an agreement with Iran on a joint action plan regarding the country’s nuclear programme. It will be implemented over the next six months. It is not a comprehensive assessment. Rather it is described as a set of ‘initial understandings’. Iran has committed to halt and dilute uranium enrichment and its enrichment capacity, as well more intrusive monitoring by the IAEA. In return, the international group has committed to a number of temporary relief measures, including the suspension of some sanctions and access to revenues from oil sales in instalments if commitments are fulfilled. However, according to the agreement, purchases of oil will merely by allowed to remain at their currently reduced levels, that are sixty per cent less than two years ago. So the agreement does not lead to an imminent rise in sales, but it does hold out the prospect for a final deal next year. During the six month initial phase, the P5+1 will negotiate the contours of a comprehensive solution.
Our central view is that Brent oil prices will drop next year
The developments over the weekend are consistent with the assumptions underlying our central scenario for oil prices over the coming months. Our energy economist Hans van Cleef sets out the reasoning behind this view in a recent research note (please see Energy Monitor, 8 November). Essentially the supply demand dynamics do not justify the level of oil prices we are seeing. The relatively elevated levels reflect a Middle East risk premium. Although there are of course various risks at play in the region, the tensions associated with Iran’s nuclear programme have been a very important part of the picture. A comprehensive agreement could have a double effect on the market. As well as directly increasing supply/supply capacity, it would also reduce the risk premium. Both factors would of course push down prices. The initial agreement over the weekend does not increase supply or completely resolve the problem, but it does show positive progress and provides a prospect of more not too far down the road. Overall, our central view is the Brent oil prices will drop in the coming months, to average USD 95 per barrel next year. The above downward pressures will only be partially offset by a gradually improving demand situation.
Dollar correlation with Treasury yields positive again
One of the most interesting elements in the currency markets last week was the relationship between what were perceived as hawkish comments from the Fed and the reaction of the US dollar. In particular, the FOMC minutes and remarks from St. Louis Fed President James Bullard put a tapering of asset purchases back into focus. The tone surprised currency markets and resulted in a recovery of the USD. What is interesting to note is that the recovery of the USD has gone hand-in-hand with a rise in the 10Y US Treasury yield. Higher Treasury yields have not resulted in a sharp deterioration in investor risk appetite, in contrast to what happened during the tapering dry run earlier this year. Investors are now more open to setting up carry trades with the Japanese yen and the Swiss franc as funding currencies. In contrast, during the tapering dry run, higher US Treasury yields resulted in a deterioration in investor sentiment reflected by a rise in the VIX. Therefore, at the time, higher yields did not support the USD. A couple of factors may be making a difference. First of all, the dry run helped investors digest the idea of tapering. Second US economic data have been fairly positive, with signs building that growth is set to step up a gear. Looking forward, we think that the combination of a US-led acceleration in global growth, higher US yields, expectations of the start of Fed rate hikes in 2015 and positive investor sentiment are likely to push the USD higher in 2014.