By Jameel Ahmad, Global Head of Currency Strategy & Market Research at FXTM
Between the Federal Reserve cutting interest rates in the United States for the first time since the 2008 global financial crisis and further escalations in the US-China trade war, which together resulted in the deepest selloff in US stock markets since early 2019, August was an eventful month for investors. Rather than the result of OPEC decisions or geopolitical tensions in the Arabian Gulf, falling oil prices are one consequence of this weakening global economic environment.
Investors are currently dealing with a number of unforeseen complexities. Firstly, they must consider US President Donald Trump’s threat to impose further tariffs on Chinese goods from September 1, and China’s subsequent retaliation through their own tariffs and allowing the USD/Yuan to trade above the psychologically important seven level for the first time in over a decade. Elsewhere, the risks of no-deal Brexit increase by the day as the October 31 deadline approaches. If investors weren’t busy enough navigating these developments, core economic data continues to threaten a world recession, geopolitical risks remain, and a number of different central banks are announcing larger-than-expected interest rate cuts to reinvigorate economic momentum.
With so much happening, it is understandable why some moves in the financial market sphere are being overlooked. One such move is the value of gold reaching its highest level since May 2013 above $1550, while at the other hand of the spectrum West Texas Intermediate (WTI) oil re-tested yearly lows marginally above $50 early August.
The decline in WTI oil hasn’t been discussed as much, but its decline is not linked to OPEC-related headlines when it comes to supply, or even geopolitical tensions that are so regularly claimed to be the catalyst behind oil price fluctuations. Instead, falling oil prices are a consequence of the weakening global economic environment.
Weakness seen in valuations is essentially a reflection of investor fears that lower global growth will hurt demand for commodities, ultimately encouraging investors to sell oil. These same concerns have led the International Energy Agency (IEA) to steadily revise demand for oil down from the 1.4 million expected earlier in 2019. Central bankers on a world level are also struggling to find solutions to a weakening global growth environment.
There has been a series of world economic downgrades since the latter half of 2018, and this shows no signs of abating. There have been pessimistic revisions to lowering global growth from institutions such as the IMF and World Bank. The World Bank expects the global economy to grow by 2.6 percent in 2019 –the slowest level of growth for world GDP since 2009, when the world economy expanded by under 1.7 percent. The IMF has also revised growth expectations lower no less than four times since last October.
Over 30 central banks have cut interest rates this year, including 13 from OECD and G20 countries, along with 24 across Asia and Africa. In fact, potentially even more alarmingly, 13 central banks have eased monetary policy more than once this year. In one week alone, lower interest rates have been announced in India, New Zealand, and Thailand. In the US, the Fed lowered interest rates at the end of July, while the consensus is already building following the latest US-China trade dispute that the Fed might be encouraged to move by up to 50 basis points (0.5 percent) as early as potentially September. The European Central Bank is expected to move in September, while the Bank of England has had internal discussions about raising interest rates in the UK at a later stage. However, its hopes of doing so will be severely hampered if the UK’s new Prime Minister Boris Johnson steers the country into a no-deal Brexit – as feared in the over five percent decline in the British sterling in the past three months.
It is true that there have been economic downturns in the past which have also correlated to weakness in oil prices. However, the current setting – an uncertain external environment compromised by several unexpected layers of unpredictable political risk – has alarmed investors. The global recession ten years ago was triggered by a meltdown in the financial market system, although the problems of today rest with several layers of unpredictable politics that has resulted in conservative behavior from investors that are now holding back from their investments.
Trade tensions between the two largest economies are contributing to global economic concerns. However, China is not alone in facing US-led protectionism on trade – many countries are alert to the risk that President Trump will impose tariffs on a number of different territories in the future, including in Europe. Protectionist policies from the United States represent only a part of the battle.
A final factor to consider is the emerging currency war. It is no secret that a trade war is taking place and recent indications suggest that the aggression is going to get worse before it gets better. In a trade war it is only natural to want a currency to remain weak, as it allows countries to benefit in exporting products and services where others are becoming more conservative towards their investments.
Weaker currencies do however, make purchasing oil at low prices appealing. After all, in the age of trade tensions with a potential currency war on the horizon, at least low oil prices would be competitive with the currency weakness that comes from this environment.
When putting together all of the above, it is important to factor into consideration that a number of different global forces are behind the recent struggles in Oil price. There are many external risks that are providing ongoing challenges to the world economy, and many of them subject to change so fast that it has become a challenge in itself to monitor day-to-day. Oil is a commodity that relies on both supply and demand, however when there are such regular downgrades to world economic health it is only natural for investors to speculate that there will be negative risks to demand for Oil.
This is the driving factor behind why Oil prices have suffered a great deal of turbulence so far this year, and we should be prepared for more of the same ahead for as long as the external environment continues to weigh down on global economic health.
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