In January, focus of financial markets shifted from Omicron strain to future policy of the Federal Reserve. The US Fed signaled its readiness to start hikes as early as this March, which became a negative factor for dynamics of risky assets. Along with that, oil prices are breaking records once again. Deputy Governor of the National Bank of the Republic of Kazakhstan Aliya Moldabekova commented what factors affected the exchange rate of tenge and international reserves last month.

– Ms. Moldabekova, what were the key events that affected financial markets in January?

– The results of the January meeting of the Fed dominated the news headlines last month. Despite the expected decision of the regulator to keep the rate unchanged at the level of 0–0.25%, the main message was readiness of the US Central Bank to start raising the rate amid worsening price growth and inflation reaching a 40-year record of 7% y/y in December 2021.

As a result, investors have significantly adjusted their expectations and laid down a faster Fed rate hike with a high probability of a quarter-percentage increase as early as March 2022. Moreover, the current market expectations point to 5 interest rate hikes by the end of this year, which is a rather tough scenario.

This led to an increase in US Treasury yields, especially in a short segment of the curve. Thus, 2-year US government securities yield in January rose by 45 b.p. to 1.18%. Against the background of expectations of higher yields, the USD strengthened by +0.9%, which puts pressure on currencies of the EM countries.

Tougher rhetoric from the Fed has led to volatility in financial markets. In January, equity markets demonstrated a significant drop, with the MSCI World index showing a –5.3% decline, with a maximum drop of 8.5% on January 27. The VIX volatility index during the month reached levels above 30, the maximum of 38.94 points was recorded on January 24, which indicates expectations of upward fluctuations of equity indices for the next 30 days.

At the same time, the impact of the omicron strain on the global economy and financial markets faded into the background during January. Despite the data on slowdown of the PMI Global Business Activity Index in January due to lockdowns and the IMF’s adjustments on economic growth prospects in 2022 to 4.4%, by 0.5 p.p. lower than last estimate, most of analysts expect a short-term effect of the new coronavirus strain on financial markets. The number of Covid-19 cases is already declining in South Africa, UK, and the US.

– How is the situation developing on the oil market since the beginning of this year?

– Easing of the concerns around Omicron strain had a positive effect on the oil market. In January, Brent crude oil prices demonstrated a significant increase, rising 17.3% to $ 91.21 per barrel, exceeding $90 level for the first time since 2014.

Since the beginning of January, the oil market has formed expectations of recovery in demand for the ‘black gold’. Data on crude oil inventories in the US showed a major decline by 4.55 million barrels in the first week of January. The director of the US International Energy Agency noted that the dynamics of oil demand was stronger than expected. In its monthly report, OPEC stated that oil inventories in OECD countries, according to latest data in November 2021, were significantly lower than the 5-year average.

In addition to the signs of demand recovery, rise in the price of oil products was influenced by the risks of decrease in oil supply amid the geopolitical events and episodes, including the risks of escalating geopolitical tensions between Russia and Ukraine and the reports of drone attacks on oil facilities in the UAE.

On February 2, a regular meeting of OPEC+ took place where the alliance members decided to increase production by 0.4 million barrels per day in March in line with the earlier reached agreements. However, it should be noted that the actual level of oil production lags behind the allowed quotas: in January, the increase was 0.25 million barrels per day instead of the planned 0.4 million barrels per day. As a result, limited oil reserves together with sluggish recovery of production by the alliance countries supported further rise of oil prices, which reached $94 per barrel on February 7. The news agenda was also influenced by the increase in prices by Saudi Arabia: according to Saudi Aramco, prices for all grades of oil for all regions will rise in March.

– What influenced depreciation of tenge in January, and what is the current situation on foreign exchange market?

– The situation on the foreign exchange market has completely returned to normal after the unprecedented events in early January. As we indicated earlier, after an almost week-long absence of trading, accumulated demand for foreign currency was formed, and in conditions of a limited number of sellers on January 12 and 13 the National Bank conducted foreign exchange interventions. Their volume reached $240 million. Afterwards, no market intervention was required during the month.

The main support for tenge was provided by positive dynamics in the oil market. However, despite rising oil prices, in January tenge depreciated by 0.4% to 433.52, reflecting global strengthening of the USD, weakening of the currencies of major trading partners and continued outflow of non-residents from the debt market of Kazakhstan.

In January 2022, investments of non-residents in government securities of the Republic of Kazakhstan decreased from 595.5 billion KZT to 543.8 billion KZT. As a result, the share of foreign participants in government securities of the Republic of Kazakhstan decreased from 4.26% to 4.04%.

The dynamics of the Russian ruble, Kazakhstan’s main trading partner, was negative during the month amid the increased geopolitical risks. Due to the tense situation with Ukraine and the threats of sanctions, ruble weakened by 2.85% over the month, on some days exceeding the level of 80 rubles per USD for the first time since November 2020.

The volume of currency supply from the National Fund for transfers to the budget in January totaled $ 696 million, and the sales by quasi-government companies sector amounted to $ 346.5 million. The increase in the Base Rate by the National Bank allowed to maintain the comparative attractiveness of tenge instruments providing additional support for tenge.

Since the beginning of February, tenge has strengthened by 1.3% to 427.95. The main factors behind the positive dynamics of the national currency are high oil price, which keeps above $90-91 per barrel, mitigation of geopolitical risks related to the situation with Ukraine and, as a consequence, strengthening of the Russian ruble (by 3% since the beginning of the month). The national currency is also supported by decreased demand for foreign currency from legal entities after active build-up of positions in November-December as well as a favorable seasonal factor before exporters’ tax payments to the republican budget.

– How have gold and foreign exchange reserves changed since the beginning of the year?

– Gold and foreign exchange reserves at the end of January amounted to $ 33.45 billion, declining by $ 930 million from the beginning of the year.

The price of gold in January decreased by 1.6%, from $ 1,820 to $ 1,791 per ounce amid strengthening dollar after the latest Fed meeting. The gold portfolio as part of the gold and foreign exchange reserves in January decreased by $1.4 billion due to a decline in the price of the precious metal and sale of gold as part of option strategies.

The change in the foreign currency part of the reserves was affected by increase in the balances of the commercial banks on correspondent accounts of the National Bank, payment of the public debt for an amount of $ 125 million, and interventions of the National Bank. As a result, hard currency assets within gold reserves rose by $430 million, which compensated to some extent the decline in gold prices.

– How did volume of foreign exchange assets of the National Fund change in January and what factors affected it?

– According to the preliminary data, at the end of January foreign exchange assets of the National Fund equaled $53.9 billion, having decreased by $ 1.4 billion over the past month.

In order to release guaranteed and targeted transfers for 302 billion tenge in the past month, assets in the amount of $696 million were sold on the foreign exchange market. Along with that, foreign exchange receipts to the National Fund in January equaled $526 million.

The investment income of the National Fund by the results of the last month was negative and amounted to $ (-)1.2 billion. As I have already noted, amid expectations of a more rapid pace of tightening of the Fed’s monetary policy as well as the negative data in the seasonal corporate reporting of IT companies, MSCI global equity index of developed countries decreased by 5.3%. The National Fund equity portfolio decreased by $650 million.

Due to strengthening of dollar and the rising interest rates, the return on the developed market bond index was negative, comprising (-)1.6%, which also had a negative impact on the National Fund’s returns.

– What are the prospects for financial markets in the near future, and what factors may affect tenge?

– Some experts, given evidence of mild symptoms in the Omicron strain, are considering scenarios that coronavirus pandemic in 2022 will acquire status of a rather manageable endemic infection. Therefore, the market concerns related to the risks of COVID-19 severity, lockdowns, and restrictions are receding into the background.

The key uncertainty in the near future that is likely to remain is the pace of tightening of the FED’s monetary policy and, as a result, the further dynamics of the US dollar. The tightening of the Fed’s policy carries the risks of negative dynamics in the equity market and further outflow of financial instruments form emerging markets.

However, I would point out the fact that the market has already laid down more than 4 Fed rate hikes this year. Therefore, further significant appreciation of the USD is unlikely. This improves the outlook for the EM currencies, including tenge. Moreover, if the current surge in the incidence of coronavirus cases comes to an end in Spring this year, it will improve prospects of global economies, resolve supply chain challenges, and have a positive impact on reducing inflation. Then, there will be less need for aggressive rate hikes by the Fed, probably global depreciation of the USD and decrease in volatility.

As for the oil market, the most likely scenario suggests that, in conditions of a limited supply and crude oil reserves, oil prices will continue to increase. Goldman Sachs raised its 12-month oil price forecast to $105 per barrel, while the JPMorgan economists, having analyzed the recent 4 cycles of rate hikes by the US regulator since 1990, noted positive dynamics for the commodity prices in each of the tightening periods.

The factor restraining the oil market is the increase in supplies both within the general policy of OPEC+ and separately from Iran. In case of successful negotiations between Iran and the United States and lifting of sanctions, around 1 million barrels per day may return to the oil market.

The tenge will continue to follow fundamental changes on foreign markets, however, internal factors already have, and will continue to have impact on the formation of the national currency exchange rate. Along with dynamics of imports and the condition of a balance of payments, the expectations for tenge exchange rate are also an important factor. The expectations for the weakening of tenge by population were mostly realized in November and December last year, when we observed significant demand for foreign currency in cash. Implementation of the medium-term measures by the Government and the National Bank to reduce import dependence and curb inflation will support tenge.

Source: Kapital.kz