To quote Vladimir Ilyich Lenin, ‘There are decades where nothing happens; and there are weeks when decades happen’. And boy, what turbulent last few weeks we have witnessed in US politics. It all started with the Presidential debate, a near-suicide for the Democratic party and culminated in the incumbent removing himself from the top of the ticket throwing an ostensible lifeline for the donkeys. The campaign has, indeed, been re-invigorated as manifested in the $81 million the presumptive candidate raised in 24 hours from the supporters and donors of the Democrats but also in the unwinding of the ‘Trump trade’ in bonds, the so-called curve steepener, reflected in the narrowing of the differential between the 2 and 10-year yields. At this stage, the divergence in policies between a Harris and a Trump administration is not unequivocally clear but what the market insinuates is that a healthy dose of unpredictability would be removed in case of the Democrat victory.

Hollywood could not have written a more edge-of-the-seat script about the presidential race but at the moment it does not have any conspicuous impact on oil prices. Yesterday’s price fall was partly the result of a stronger dollar and the sentiment soured further on revived hope of ceasefire talks between Israel and Hamas. Yet, we do not subscribe to this proposition as the major price driver because a.) Benjamin Netanyahu would probably continue his crusade against the terrorist organization and so would the Houthis their campaign in the Red Sea and b.) oil supply would not be meaningfully affected either way.

A more realistic scenario is to pin the sell-off on diminishing hopes of demand resurrection. The weakening of the WTI and Brent structure in the last 3-4 days might be an admission from refiners that the summer leap in consumption is simply not taking place, something that is ominously confirmed by the 565 points plunge in front-month RBOB futures. Anticipation of imminentish rate cuts both from the ECB and the Fed will set a floor under the market but it would rather be an encouraging bounce than the re-establishment of the uptrend. For the latter scenario to play out, considerable stock draws, particularly in gasoline inventories, will have to take shape. Last night’s across-the-board declines reported by the API is a welcome start of the process but a few weeks of decline and decisive improvements in crack spread values are what would push the price of oil towards the peaks 3 weeks ago and beyond.

Beggar-Thy-Neigbour

There is no extensive common ground between the current and previous US administrations, the ideological differences are simply unbridgeable, especially in today’s toxic and fragmented political and social environment yet, the approach towards China is intriguingly aligned. The tariffs Donald Trump imposed on the world’s second biggest economy remained largely intact during the Biden years and will plausibly stay in place or even intensify should Donald Trump gain access to the White House once again. Notwithstanding this continuity, it is discernible that yuan has weakened considerably in the last two and a half years. Since the beginning of 2022 it has depreciated nearly 15% against the dollar. During this period, the dollar index strengthened less than 9%.
There are two salient reasons for this frailty. Looking at the broader picture, the Chinese currency is pegged to a basket of currencies with the composition of this basket determined by the trading volume of the country’s partners. Until 2005, the yuan exclusively followed the dollar and the fact that it is now managed against several other currencies says a lot about the political and the economic relationship of the two juggernauts. The purpose of the currency peg is to keep the yuan relatively weak, thus incentivizing Chinese exports as in this circumstance Chinese goods will be more attractive than its competitors’.

Exports are one of the foundations of economic prosperity as it entails money flowing into China. In its effort to keep the yuan undervalued or at least its exchange rate comparatively low the People’s Bank of China has been active in the foreign exchange market. Its reserves have leapt from $615 billion in 2004 to $3.2 trillion by the end of last month.

Pegging one’s currency against a basket as opposed to float it and the let the market decide the true value of it leads to accusations of currency manipulation and potentially to currency war or using the politically correct phrase to ‘competitive devaluation’. Whilst China has been reaping the benefit of its weak yuan, at least until the pandemic, others have had to bear the consequences, the most prominent of which is the US. Manufacturers there have long complained about Chinese trade surplus and pointed to unfair comparative advantage the weak yuan yields. Law makers, therefore, especially in the run up of elections, call for the re-valuation of the yuan and rhetoric on imports tariffs gets louder. The other side of the coin, however, is that the yuan peg results in cheap goods for US consumers therefore tariffs need to be finely balanced not to hurt consumers more severely than benefit manufacturers, something that has been, rightly or wrongly, casually ignored by successive administrations in the name of national security.

The second reason for the depressed yuan can be found in the differences of interest rates. The dollar and several other currencies of major economies received a timely boost when the fight against inflation started in 2023 and interest rates were on the ascent. At the same time, the 1-year loan prime rate (LPR) in China has edged south from 3.8% in 2022 to below 3.4% this month with the latest cut announced on Monday. Of course, raising the cost of borrowing should help the yuan strengthen again. This is, nonetheless, something that the country’s leadership and the central bank will improbably advocate. It would do nothing to mitigate the negative impact the deflationary pressure precipitates and if anything, even weaker currency would be needed. This can be achieved by cutting rates further, which could boost lending and consumer spending. And herein lies the trap. Further weakness in the yuan exchange rate would rachet up much-needed inflationary pressure and would act as additional encouragement to export. On the flip side, perpetually growing trade surplus would alienate trading partners, particularly the US and the EU, and would escalate the odds of a full-blown trade war. An unbearably weak yuan would also serve as an encouragement to find creative ways for money to leave the country despite capital control ensued by a potentially significant fall in foreign exchange reserves. Finally, the same way as a weak currency motivates exports, it discourages imports and could compound the declining thirst for foreign crude oil completely pulling a layer of support from under the oil market.

Overnight Pricing

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