Oil surges after output cuts, strong dollar weighs

By Saikat Chatterjee

HONG KONG (Reuters) - Oil prices jumped to their highest levels in a year and a half on Monday after OPEC and non-OPEC producers agreed to cut oil output to ease a global glut, while the U.S. dollar extended gains before a Federal Reserve meeting this week, at which a rate hike is widely expected.

The agreement between OPEC and a number of other oil producing nations was the first joint action since 2001, following more than two years of low prices that strained many government's budgets and spurred unrest in countries from the Middle East to Latin America.

Brent futures for February delivery rose 5 percent to $56.94 per barrel, with U.S. crude spiking a similar amount to $54.07 per barrel in early Asian trade before trimming gains.

The spike in oil prices comes in the wake of a renewed focus on inflation after data on Friday showed a rare spike in producer prices in China, prompting investors to worry that inflationary pressures are making a come back globally.

"We have seen OPEC and non-OPEC producers agreeing, which is also boosting reflation expectation around the world," said Chris Weston, an institutional dealer with IG Markets.

In another sign of the reflation trade, breakeven rates - the gap between yields of five-year U.S. debt and a matching tenor in inflation-protected securities was at two-month highs, indicating markets are expecting inflation to accelerate.

"Traders want to be hedged against this situation, so people are buying financials globally. Everyone wants to benefit from a reflation trade, and financials are generally your natural hedge against that."

Though MSCI's broadest index of Asia-Pacific shares outside Japan was broadly flat after posting its biggest weekly rise in nearly three months last week, energy plays in Hong Kong and Shanghai such as CNOOC and PetroChina were among the top gainers.

Despite the bounce in some Asian stocks, broad investor sentiment remained cautious from a flows perspective with data showing a pick up in outflows from emerging markets and inflows towards U.S. markets, according to Jefferies analysts.

A preliminary survey from the University of Michigan on Friday showed U.S. consumer sentiment index at its highest since January 2015, which may see the Fed strike a more confident tone on the U.S. economic outlook at its final policy meeting of 2016 on Tuesday.

Futures have virtually priced in a rate increase this week while the greenback gained fresh legs from the data, posting a 10-month high against the Japanese yen and standing tall against a trade-weighted basket of peers.

The euro was trading near a one-year low against the dollar with the common currency changing hands at 1.055 per dollar. Analysts at BBH expect a rebound to 1.07 per dollar if the 1.05 level is not broken.

Morgan Stanley economists expect six rate increases between now and end-2018 and say that any dollar pause is an opportunity to add to long positions though some analysts adopted a more cautious stance.

"The markets are expecting too much from the Fed and that is what latecomers to the dollar rally will be thinking," said Cliff Tan, a markets strategist at Bank of Tokyo-Mitsubishi UFJ.

In the bond markets, the U.S. Treasury yield curve steepened further with the spread between 10-year and two-year bond yields reaching a one-year high of 135 basis points. It has gained 35 basis points over the last month.

Gold prices edged lower amid a broad rise in risk appetite with spot gold hitting its lowest since Feb. 5 at $1,153.93 an ounce and was down 0.3 percent.

(Additional reporting by Rushil Dutta in BENGALURU; Editing by Kim Coghill and Eric Meijer)