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Oil price turbulence rattles global economy
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Several emerging market currencies are wallowing at multi-year lows relative to the US dollar, as falling commodity prices and China’s equity volatility reverberate through the global economy. In turn, August began with oil prices plunging to multi-months lows.
A few weeks ago, the IMF projected global growth at 3.3 percent in 2015, marginally lower than in 2014. As a result, commodity prices, particularly for oil, took a plunge.
Major advanced economies are just now in the midst of a fragile recovery, while growth in large emerging economies is slowing or contracting. As a result, neither group is likely to accelerate global demand for oil.
Supply forces are struggling as well. As the number of oil drilling rigs in the US rose, the supply glut showed few signs of abating anytime soon. The prospects of a rebound in the second half are weaker and the threat of new lows is elevated.
Until recently, oil prices were recovering. But after rallying earlier in the year, oil plunged nearly 20 percent in July (and briefly fell below US$47 per barrel). In the past, such plunges have often heralded the coming of a bear market.
Since oil is a dollar-denominated commodity, the timing of the impending interest rate hike in the US has had a significant impact on the US dollar and thus on oil prices. Monetary hawks expect the Fed to raise short-term interest rates by September; doves, by December 2015.
Still others, including the IMF, have warned about the adverse impact of premature rate hikes, arguing that the Fed should delay the rate hike until 2016. Many central banks have hiked rates prematurely. However, if the Fed does the same, the implications would be global.
Inverse relationship
The US dollar and oil have an inverse relationship. When the value of the dollar goes up, oil price tends to come down. Conversely, when dollar falls, oil tends to go up.
In the course of the past year, expectations of rate hikes have pushed the dollar up, while Europe’s crises have caused the euro to fall and oil prices have plunged. As a result, the US dollar index, which measures the value of the greenback relative to a basket of foreign currencies, has soared from 82 in August 2014 to 97 today.
Currently, markets are holding their breath.
In addition to the US dollar and the Fed’s impending decisions, oil prices have been impacted by persistent oversupply fears, which emerged as a result of the US shale revolution. Looking ahead, the nuclear deal with Iran is likely to result in Tehran’s increased oil exports.
At the same time, the international currency environment is about to change as China and the IMF are working to make the renminbi a reserve currency, possibly by October, when the IMF will hold its vote on the issue.
The Fed’s impending rate hike will prove challenging to emerging markets, particularly those economies (such as Nigeria and Colombia, among others) in which growth or trade rely on oil revenues.
In contrast, China’s economy is larger, more diversified and not reliant on oil exports.
The good news is that plunging oil prices support Chinese economic reforms and thus the rebalancing from investment and exports to consumption and innovation. However, turbulence will increase once the Fed will begin to hike interest rates. That’s when the real rollercoaster ride will begin.
Dan Steinbock is the research director of international business at the India, China and America Institute (USA) a visiting fellow at the Shanghai Institutes for International Studies (China) and at EU Center (Singapore). For more, see http://www.differencegroup.net
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