Emirates NBD CIO: Higher oil prices could spike the market's rise (page 1 of 2)

By Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD

The recent 10% rise in oil prices if sustained will detract from global growth and slow the pace of interest rate cuts in the emerging countries. The situation in Greece is better but still far from secure and any significant setback in negotiations could lead to some rapid profit taking. However what is also clear is that the days of investors hiding in 100% cash or near cash are behind us.

Central banks have collectively provided such significant amounts of stimulus to the global economy that some risk taking by investors bored with near zero interest rates was inevitable. The cash continues to seek higher yield in bonds and equities driving prices higher.

To the benefit of financial markets there is still a good deal of cash chasing around the global economic system. Global liquidity remains strong with all of the major central banks continuing to provide support. Last week the Bank of Japan to the surprise of the market formalized an inflation target and announced a Yen 10 trillion asset purchase program.

Even for the Japanese authorities who have been fighting an economic crisis for over a decade the new measures were a major step up in activity. The scale of the asset purchase program is quite staggering, sufficient to buy up all of the new bond issuance by the Japanese government over the next year. In the coming few weeks the European Central Bank will push ahead with a further tranche of asset purchases. Central bank action has forced down government bond yields and encouraged investors to take more risk by investing in higher yielding bonds and equities.

Oil prices and higher inflation

The rise in the oil price has the potential to crack or at least moderate the rise in markets seen in recent weeks. The oil price has risen 10% in the last two weeks as stronger than expected global demand growth has met supply worries. The rising market concerns about the Iranian situation has led to a spike in oil prices to $120 per barrel, the highest prices since May 2011. If the oil price rise is sustained then there could be quite a challenge to the markets.

Higher oil prices means higher inflation, higher inflation would apply a brake to the reduction of interest rates that we have been witnessing in the emerging markets. China's latest inflation data was higher than expected. Only with lower inflation can the Chinese authorities press ahead with a further easing of monetary policy through lower interest rates and less of a restraint on lending.

Although in recent weeks some good progress has been made on propping up Greece there remain hazards ahead. European leaders meet on February 20th to discuss a further package of measures for Greece to meet in order that a Greece receives sufficient funds to take it through its next bond redemption on March 20th. In April Greece faces a general election where it is possible that due to public dissent a very different government takes office that could renege on some of the promises of the current administration. Also bear in mind that whilst the current politicians may promise to cut spending and increase taxes it is open to debate as to whether the measures achieve the improvement in the government deficit needed.

Economic challenges, but a positive outlook

Irrespective of some of the challenges ahead it is clear that retail investors are back buying equities. As an example flows of investor money into equity mutual funds that invest in emerging markets have seen inflows year-to-date of some $19 billion equivalent to 60% of the total outflow of last year.