Dollar Shake-ups, Israel-Hamas Peace Spark, Korea Splits

Hi all,

OPEC members cannot agree on production cuts, challenges with the Argentina obscure dollarization plans, China’s successful ANTI-dollarization efforts, Kim Jong Un’s abandonment of South Korea, and a temporary truce between Israel and Hamas.

Let’s dissect.

Markets Snapshot

Oil Prices

• Crude oil prices continue to be volatilite and hover around the 80$ per barrel mark.

• There was an unexpected 8.7 million barrel increase in the US crude inventories last week, exceeding the forecasted 1.16 million barrel rise. Concerns about robust supplies have prompted speculation on potential OPEC+ actions, such as extending or intensifying supply cuts. Disputes over output levels, particularly among African members like Angola, Congo, and Nigeria, seeking to raise their 2024 quotas beyond the agreed provisional levels set by the OPEC+ in June, have led to the postponement of the policy meeting in Vienna.

• China's initiative to provide over 1 trillion yuan (USD 137 billion) to the nation’s urban village renovation and affordable housing programs is seen as a positive factor for the oil market's near-term outlook, fueling expectations of increased demand. This development partially counteracts the downward shift in prices caused by increased supply.

Equity

• Over the past month, the S&P 500 index, which tracks the largest publicly traded US companies, has seen a 7.8% increase. Unlike central banks worldwide, which have adopted a cautious approach, U.S. equity investors are optimistic that lower-than-expected inflation, coupled with positive growth indicators, will prompt an earlier reduction in interest rates without triggering a significant recession.

Global Finance

Fed is Cautious of Two-sided Risks

• The minutes of the latest Federal Open Market Committee meeting released last Tuesday reflected unanimity among members that monetary policy must remain restrictive “for some time” until inflation is clearly moving toward the Federal Reserve’s 2% goal.

• The potential for further tightening was acknowledged if insufficient progress is made toward the inflation target, despite the inflation rate remaining significantly above the target.

• The Fed's confidence in inflation returning to target depends on diminishing inflation pressures, resulting in the maintenance of the federal funds rate at a 22-year high of 5.25%-5.5% in November.

• Given the uncertainty surrounding various economic indicators, Fed officials provided no indication during the meeting that they were considering rate cuts.

Our thoughts:

• As noted by the Fed as well, it is important to balance the risk of tightening policy too much against the danger of doing too little. Stricter financial conditions arising from sustained higher rates could have more significant consequences than anticipated for the budgets of U.S. households and businesses.

• Nevertheless, the document didn't trigger significant movements in financial markets, largely reinforcing the notion that the Fed has concluded its rate hikes but is refraining from explicitly stating so until Fed officials become fully convinced that inflation won't rebound.

New "Anarcho-capitalist" Leading Dollarization Efforts in Argentina

• As you could have read already, the self-proclaimed "anarcho-capitalist" Javier Milei, who once wielded a chainsaw on one of the presidential campaign trails to symbolize his intent to cut governemnt spending, won presidential election in Argentina last Monday. Securing nearly 56% of the votes in the decisive run-off, Milei surpassed his left-wing rival, Sergio Massa, who garnered 44%.

• He has committed to implementing measures such as dollarizing the economy, ‘burning’ the nation's central bank, and privatizing the pension system.

• The Argentine peso in parallel markets experienced a significant drop, falling over 10% to 1,000 per USD, following the election.

• Banking sector has also reacted very apprehensively. Argentine banks have started shifting from Leliq notes issued by the central bank to shorter, lower-yielding securities to enhance liquidity, expressing concerns over Milei's unclear approach to debt management.

Our thoughts:

• The decreased rollover of Leliqs, down from 40% to 10% in recent auctions, may inject more pesos into the economy, potentially intensifying the existing high annual inflation rate of 143%.

• Dollarization of the economy would not itself solve fiscal and monetary imbalances. With scarce international reserves, which have already declined to $20.9 billion, a more significant depreciation of the exchange rate will be necessary upon conversion. However, this would still result in the devaluation of depositors' funds in the banks, which makes the whole idea of full dollarization hardly feasible.

• Fiscal adjustments and fiscal discipline measures could maintain monetary sovereignty and provide more balanced approach towards stabilizing the economy.

• Already causing market unease, Milei must explain more thoroughly the merits of his economic and fiscal strategies, providing a detailed plan on their implementation.

While Saudi Arabia and China Push for DE-dollarization

• The Saudi Central Bank and the People’s Bank of China have signed a three-year local currency swap agreement worth $6.93 billion allowing trade between two countries to be conducted in riyals and yuan instead of the USD. It marks another successful step in China’s dedollarization campaign and internationalization of the yuan.

  Currency swap agreements are financial contracts between two nations to exchange a predetermined amount of one currency for an equivalent value in another currency. Hence, the agreement will help China to price transactions of oil derivatives in its own currency

• Being primary oil supplier to China, Saudi exported $65 billion worth of crude oil to the country in 2022 according to the Reuters data. Two countries have strengthened their trading relations, expanding collaboration beyond hydrocarbons to the areas like modern transport systems, tourism, and technology.

• China has recent;y signed other currency swap deals, including one with Argentina, bringing the total to 29 agreements with a cumulative value exceeding 4 trillion yuan.

• Earlier this month, the yuan overtook the euro to become the second most used trade currency. The Chinese currency now represents 5.8% of trade settlement, up from 3.9% at the beginning of the year. While the internationalization efforts of the yuan are notable, it still falls significantly short of the dollar's dominance at 84.2%.

Geopolitics

Israel and Hamas Temporary Truce

• Israel and Hamas have reached a temporary ceasefire deal in the war, facilitating the release of around 50 individuals held captive in Gaza since October 7. The agreement, backed by the Israeli cabinet, involves the exchange of these captives for Palestinians held in Israeli jails.

• The deal, facilitated by Qatar, stipulates the release of the hostages during a four-day truce. The pause's duration can be extended by a day for every additional 10 hostages released.

• Both sides have confirmed the agreement, with Hamas stating that 50 women and children in Gaza will be freed in exchange for Israel releasing 150 Palestinian women and children from its jails.

• On a significant Friday in history, Hamas released the first 24 hostages, and in return, Israel freed 39 Palestinian prisoners. This marks the first exchange in more than six weeks of the war. On the subsequent Saturday night, Hamas freed 13 Israeli civilians and four Thai nationals, leading to the release of 39 Palestinian women and children by Israeli authorities in response.

Kim Jong Un Ditches South Korea's Military Pact

• North Korea has declared its intention to deploy additional troops and military equipment to the border with South Korea. Furthermore, the country has announced its decision to no longer adhere to a 2018 joint military agreement, as Seoul suspended certain aspects of the agreement in reaction to Pyongyang's launch of a military spy satellite.

• The Comprehensive Military Agreement (CMA) was signed during a 2018 summit between North Korean leader Kim Jong Un and former South Korean President Moon Jae-in. This agreement aimed to diminish tensions on the peninsula and foster trust between the two countries.

Implications:

• Kim's potential easing of restrictions on weapons deployments and maneuvers near the Korean Demilitarized Zone (DMZ), following the abandonment of the agreement with the South, increases the risks of miscalculation and conflict escalation on the Korean Peninsula.

  Additionally, the communist government may escalate drone activity, potentially extending into South Korean territory, as has previously occurred.