Market analysis: The year starts on a high but volatility will follow

Above, an oil tanker anchored off the Fos-Lavera oil hub near Marseille, France. The outlook for this year appears better, with oil prices expected to average US$55 per barrel compared with $45 per barrel in 2016. Jean-Paul Pelissier / ReutersShow less

Financial markets have kicked off 2017 on a more positive note than they started 2016: the S&P 500 hit a new record high and the Dow Jones Industrial Average continued to flirt with 20,000, but has yet to breach this psychological level. In the UK, the FTSE100 index closed at a new record high for nine straight sessions from December 28.

More relevant for our region, oil prices are trading in the mid-50s (US$ per barrel) compared with about $30 per barrel a year ago. We know that the Opec agreement in November to cut oil production in the first half of this year is one of the main reasons for the firmer oil price, but the strong performance of global equities even in the face of significant geopolitical uncertainty can be attributed in part to better than expected economic data over the past few weeks.

Globally, measures of economic activity have consistently beat expectations so far in January. Various purchasing managers’ indices (PMI) in China, the euro zone, UK and the US came in higher than forecast for December, suggesting that economic activity in manufacturing and services sectors is robust. Other measures of activity in the US, such as the ISM surveys, have also been stronger than expected. All of this bodes well for economic growth, particularly in the US.

In the GCC too, the Emirates NBD PMI surveys showed that economic activity gained momentum at the end of 2016. The UAE PMI rose to a five-month high in December, as did the Dubai Economy Tracker. While the headline index readings look solid, they mask a couple of less encouraging trends: the growth in business activity last year did not create many new jobs and companies’ margins have been squeezed as they have reduced selling prices to secure work. Last year was undoubtedly challenging for businesses in the region, with cuts to government spending in the largest economy (Saudi Arabia) having a ripple effect across the GCC, low oil prices and a strong US dollar all proving headwinds to growth.

The outlook for this year appears better, with oil prices expected to average $55 per barrel compared with $45 per barrel in 2016. This should boost government revenue and reduce the need for further cuts to public spending. For the UAE, and Dubai in particular, preparations for Expo 2020 are expected to move up a gear, which means higher spending on infrastructure projects, and that should underpin broader economic growth.

However, challenges and uncertainties remain. The US Federal Reserve is expected to accelerate the pace of monetary policy tightening this year, with the Fed’s own projections suggesting three rate hikes are on the cards. This means US dollar strength will probably continue to erode competitiveness in the GCC and remain a headwind to growth.

Political uncertainty in developed economies is likely to remain high this year and will probably be reflected in increased financial market volatility. The incoming US administration will be putting the finishing touches on a range of executive orders and other measures which the president-elect, Donald Trump, is expected to implement after his inauguration, outlining his top policy priorities. These are expected to include tax reforms, rolling back of regulations around health insurance and financial services and increased spending on infrastructure. However, the president-elect has offered very little detail on what these reforms will look like and there is a risk that markets have been too optimistic in regards to what will actually be delivered.

In Europe, uncertainty about Brexit is likely to rise as the UK prepares to trigger Article 50 and start formal negotiations with the rest of the EU by the end of March. At the same time, several EU nations will be gearing up for their own elections, including the Netherlands in March, France in May and Germany around September/October. So while financial markets have started 2017 on a wave of optimism and ebullience, the sailing is unlikely to be smooth.

Khatija Haque is head of Mena research at Emirates NBD.

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