Politics and the pandemic shake up the markets

English Section / 23 septembrie 2020

Politics and the pandemic shake up the markets

The pension hike accelerates the weakening trend of the RON and raises borrowing costs

The Leu has reacted differently against various currencies, during the pandemic, with the EUR/RON exchange rate going up, while the opposite happened to USD/RON. The latter happened because of the weakening of the dollar against the Euro, during the crisis caused by Covid-19, as well as following the political events happening on a national and global level.

The last event that happened in the Romanian parliament, respectively the vote of September 22nd to raise pensions, has exacerbated the weakening trend of the Leu against the Euro and in less than 30 minutes, raised the government's long term borrowing costs.

The euro/leu exchange rate had begun rising just a few seconds after the vote, to 4.862 on the interbank market. One hour after the vote, the exchange rate even reached 4.864 lei/Euro. The maximum level of the official exchange rate officially announced by the NBR, was set last week at 4.8595 lei/Euro. Yesterday, one Euro was priced at 4.8590 lei - the amount announced by the NBR.

The rise of the Euro also means price increases on imported products, as well on other services billed in Euros, such as telecommunications. In March (March 16th, for instance), the EUR/RON exchange rate was 4.8242.

The 3-month ROBOR index also rose yesterday. It is used to calculate the interest rates for some loans denominated in lei. It rose two basis points, to 1.98%, from 1.96%. 6-month ROBOR also rose one basis point, from 2.03% to 2.04%.

The interest rates on Romanian government bonds had generally dropped last week to a 3-year low, but in anticipation of yesterday's vote the yield curve (the chart which reflects the interest rates for government bonds charged at a specific time, on the secondary market, for all maturities) moved upward, on Monday, by two basis points, on average. The interest rate on government bonds for the 10-year maturity had thus risen to 3.435% from 3.40% (the 2017 low) on Friday, and yesterday's vote led to a long-term yield of 3.55% in less than 30 minutes. During the debates in the Parliament the 10-year yield had risen to 3.490%.

The PNL has announced that it would challenge at the CCR the amendment of the budget revision by the Parliament, which on top of the 14% pension increase further stipulates additional expenses which have to be financed via borrowing.

If the Emergency Government Ordinance for the rectification passes the constitutionality test, president Klaus Iohannis can submit the draft to the Parliament, which seems the most probable course of the events.

Ionuţ Dumitru, chief-economist of Raiffeisen Bank and former president of the Fiscal Council, said on Digi24 that if pensions get raised 40%, then the budget deficit will go to 12% of the GDP and in order to make up the expenses we will have to resort to the International Monetary Fund (FMI).

The Romanian Government is unable to finance deficits of 10%-12% din PIB from the Romanian market alone, meaning that it needs to access the international markets. A sovereign rating cut would mean an additional increase of the sovereign risk premium and therefore, a hike of the interest rates charged on loans and the potential weakening of the EUR/RON exchange rate.

The odds for the depreciation of the leu against the Euro had already increased

Monday morning, the exchange rate was pushed on the international market as far as 4.87 lei/Euro. In the minute of its meeting of August 5, the National Bank of Romania was warning politicians in the minute of the August 5th meeting that increased domestic tensions could raise the sovereign risk premium, with consequences on the volatility of the exchange rate of the leu, and implicitly on inflation and trust in the national currency.

Analysts are in a consensus when it comes to the weakening of the leu, amid the twin deficits which are expected to increase this year. The leu has remained stable during the summer months, compared to the Euro, following the interventions of the National Bank of Romania (NBR). The leu is sensitive to any risk aversion on the international markets, just like the other currencies in the region, which was noticed in early September.

BCR analysts also show, in an analysis report published in the beginning of the week: "Last week the leu stayed within a very narrow band compared to the Euro, respectively 4.8550-4.8600, according to the exchange rate posted by the NBR every day. EUR/RON turnover increased over the past weeks, after the holidays ended, with daily peaks around noon, when the NBR announced the official quotes. On other markets in the region, such as Hungary and the Czech Republic, a trend of their respective currencies weakening against the Euro was noted, including due to worries induced by the increase in the number of COVID-19. For the end of this year, we estimate a RON exchange rate of 4.9. The medium- and long-term depreciation trend for the leu is the result of the large current account deficit and the fragile fiscal position".

Analysts of BT Asset Management also predict an exchange rate of 4.88 for the end of 2020 and 4.97 for the end of 2021. The Eur/RON exchange rate, as well as the interest rates the government borrows at, also remain sensitive to the constant spending increases in the Parliament and the electoral dynamic, as the MPs seem to have no intention of accepting the reality of the budget.

Claudiu Cazacu, consulting strategist at XTB România, recently stated that the level of 4.96 lei/Euro could be reached at the end of this year.

Divergences between the EUR/RON and the USD/RON exchange rate, this summer

EUR/RON and USD/RON exchange rates had diverging evolutions during the summer, amid the weakening of the American currency.

This summer, the EUR/USD exchange rate passed the psychological threshold of 1.2, amid the European turnaround deal agreed upon by the EU leaders, but later fell back, and yesterday, was trading at a six-week low, below 1.175, amid a rise in the demand for dollars.

This summer, short positions on the dollar have been very high, and their decrease stabilized the American currency, according to BT Asset Management analysts.

The number of Covid infections in Europe has continued to put pressure on the Euro, and international analysts were expecting the emphasis of the downward pressure. The dollar traded yesterday and will be trading today and tomorrow under the influence of statements by Fed president Jerome Powell, who has statements scheduled in Congress concerning the central bank's response to the pandemic.

When it comes to the EUR/USD level, Phillip Lane, ECB chief-economist, was saying that after the 1.2 threshold was passed on September 2nd, that the level of the Euro "really matters" for the monetary policy, and that is in the contest where a stronger Euro makes the continent's exports more competitive and affects the speed of the economic recovery. Lane's remark represented the first real pushback from the ECB concerning the strengthening of the exchange rate this summer, in the context where the 1.2 level would be "the line in the sand" for the ECB.

In a speech held on Monday in Berlin, ECB president Christine Lagarde has expressed her concern on the strengthening of the exchange rate of the Euro and signaled the prospect of the implementation of new quantitative easing measures to support the post pandemic recovery process in the region.

Going back to the national currency and to the depreciation trend which was felt yesterday on the interbank market after the vote in the Parliament, we should mention the statements of analyst Dragoş Cabat, who recently told us that the national bank has kept the exchange rate stable for the last few months, to send a signal that things are under control in the economy.

"The idea is that the national bank wants to send a signal of stability, a sign that things are under control. Especially since this is an electoral period and it is not in the habit of the national bank to go in, - regardless of who has been in charge, the PSD or the PNL -, to intervene especially during electoral periods and to endorse exchange rate and monetary policy fluctuations. And so over this period it will keep the exchange rate stable. If, Heaven forbid, something happens, a disaster, then sure the national bank won' t intervene either: it will allow the exchange rate to move and intervene when the situation stabilizes. But now, during the pre-electoral or electoral period, the national bank does not implement partisan policies to avoid being accused of having favored one side or the other in the elections", said Cabat, who further said that he expects the stability of the exchange rate until after the parliamentary elections of December.

The outlook for crude is predominantly negative, as there is talk in some circles about "the death of Big Oil"

Oil has traded in a very narrow range starting with this summer, predominantly between 40 and 45 dollars/barrel, and the outlook is that the price of oil will remain in that range at least in the short to medium term. In the long term, the outlook could be of a maximum Brent price of 65 dollars, by 2035.

Relevant in this case is the freshly updated forecast of OMV Petrom (SNP), the biggest oil and natural gas company in South-East Europe, which has revised its long term estimate for the price of Brent crude, used in drawing up its budget, from 70 dollars a barrel to 60 dollars a barrel.

For 2021, Petrom estimates a price of 50 dollars/barrel, following the ongoing effects of the Covid-19 pandemic. For 2022-2023, OMV Petrom expects a median price of 60 dollars/barrel, 65 dollars/barrel for the 2024-2029 period, and until 2035 a downward trend for Brent, to 60 dollars/barrel. Petrom estimates are for the most part in line with, and in some cases, a little more optimistic than those of the various agencies and international organizations.

According to short-term estimates of the US Energy Bureau, the median price for the Brent barrel in 2020 will be 41.4 USD and 49.5 dollars in 2021. In 2019, the Brent median was 64.3 dollars/barrel. The OCDE expects 40 dollars/Brent barrel in 2020 and 2021, the IMF FMI 37 dollars in 2020 and 39-40 in 2021, and the World Bank 42 dollars/barrel in 2021, 52 dollars in 2025 and 70 dollars in 2030.

The International Energy Agency (IEA) expects market demand to remain low (remote work, slower turnaround of the global economy this year and the drop in air travel), which is the fundament for trading at the same levels as the current ones, over the short term. The supply is also oversized and it ought to remain so in the long term, as the US has become the biggest producer, and the American supply puts downward pressure on prices.

Currently, the other oil exporting countries (OPEC) are still discussing output cuts/the implementation of those that have already been agreed upon. Saudi Arabia for instance, is pressing OPEC countries (United Arab Emirates, Nigeria, Iraq) to stand by their commitments to lower output - attempts to cheat are easier to track now thanks to technology.

It bears mentioning that in certain circles there is talk about "the slow death of Big Oil" and the fact that "the industry needs to reinvent itself if it wants to survive in a low carbon emissions era".

Gold also fell in the beginning of the week, correlating with risk assets

The price of gold (XAU/USD) also fell in the beginning of the week, unexpectedly correlating with with risk assets which have collapsed, among other things, following the revelations in the press about suspicious trades in the last two decades which concern the biggest banks in the world. Stock markets at least have continued, in the beginning of the week the correction which began in early September after reaching some highs which were considered exaggerated.

After reaching all-time highs in the beginning of August (2070 dollars/ounce), XAU/USD has corrected itself, in the last two days, to 1900 dollars, where it has stabilized at the six weeks support line.

It bears mentioning that the August low, of 1860 dollars/ounce, it offers a different support level, which maintains the positive outlook in the medium term, despite a possible retesting of that level, according to FXStreet.com analysts.

The drop in gold is practically explained by the 0.68% strengthening of the dollar (DXY Index) on Monday. Yesterday, gold was once again hurt by a stronger dollar.

This summer, gold massively benefited from the weakening of the dollar and the interest cuts operated by the Federal Reserve, starting with the Covid crisis, as well as by the prospects of the Fed keeping interest rates low at least until 2022-2023 (the years suggested as the period when the contraction caused by the quarantine will have been reversed completely). Yesterday's consolidation at 1900 dollars an ounce came amid a stability in American futures quotations.

"Our long term outlook for gold is keeping an eye on the support level. The combination between the protection against inflation which causes demand, the outlook for a weaker dollar and the positive points of view concerning the moment when a vaccine against Covid-19 becomes available (is) an optimistic mix. Given these developments and the potential for a very «nasty» electoral period in the US, we stand by our bullish outlook for gold. Meanwhile, in the short term,the performance of mega-cap American stocks and the dollar hold the key to the direction. As a result, it is likely that the two-month consolidation period will continue to be extended", says Ole Hansen, commodities strategy director at Saxo Bank, in a recent analysis.

Cryptocurrencies have surprisingly collapsed in the beginning of the week

Just as surprising has been the evolution of the main cryptocurrencies, which have decreased in the beginning of the week together with gold, returns on government bonds and risk assets.

Bitcoin, the most traded cryptocurrency, fell 4.58% on Monday, from 10.934 dollars to 10.434 dollars, the biggest drop since the 10.8% one of September 3rd. The market cap of the digital currency was yesterday about 194.1 billion dollars, according to "coinmarketcap.com".

After falling on Monday, interest rates fell yesterday, amid improving market climate

Interest rates on the most important government bonds (German and American) on the global financial market also fell following Monday's risk aversion on the stock exchanges and the higher demand for safe havens. Yesterday was recorded an upward resumption of returns.

"Concerns about the intensification of the pandemic, news concerning some important banks (HSBC) and the evolution of the price of crude and other commodities have felt their presence felt on the financial market in Monday's trading session. The interest rate on German sovereign bonds with a 10-year maturity fell to -0.527%,, EuroStoxx 50 lost 3.7%, and EUR/USD fell 0.39% to 1.1787 (the ECB rate). (...) The interest rate on 10-year American government bonds decreased to 0.669%, the Dow Jones index fell 1.8%, and the dollar gained 0.39% compared to the Euro", says Andrei Rădulescu, chief-economist at Banca Transilvania.

It bears mentioning that in the United States, the economic activity of Chicago rose for the fourth month in a row, in August, according to a report.

A bit more solid turnaround in the yields of American government bonds have indicated an apparent recovery of the positive climate on the financial markets.

Rădulescu also says that "in his speech in the House of Representatives, FED chairman (Jerome Powell) warned that the post pandemic turnaround will be a lengthy process, characterized by persistent risk".

"In this context, the representative of the central bank stressed the importance of implementing new measures to support the American economy", the Banca Transilvania official said.

Concerning Romania's interest rates on government bonds, on Monday, the yield curve traveled upwards slightly on Monday, in anticipation of the vote in the Parliament by two basis points on average: the interest rate on 10-year government bonds rose to 3.435%.

The Finance Minister reopened on Monday, an issue of sovereign bonds coming due in October 2023 and has borrowed 535 million lei (above the scheduled amount of 500 million RON), at an annual median cost of 3.05%, down 20 basis points compared to the previous auction at the end of last month.

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