There is no doubting that sentiment in financial markets has been truly awful since the start of the year. The slump in oil prices and concerns over the effect of China’s currency depreciation on the global economy are uppermost in investors’ minds.
Unlike this time last year, when many commentators thought the decline in the oil price was an unambiguous positive for the global economy, this time declines in the oil price are perceived as deflationary by most. For some commodity producers, the decline in the oil price has triggered record lows in the value of the currency, or where the currency is pegged, has resulted in a downturn of FX reserves. Lower oil prices have also exposed high break-even oil prices with regards to fiscal budgets and the balance of payments, especially in this region.
Much of the problem is about confidence, which in China’s case curiously seems to vaporise once major holidays are out of the way. After the summer holidays last year we were told that China’s weak markets were threatening the world economy, so much so that the US Federal Reserve delayed raising interest rates – something that is now widely viewed as a policy mistake. Now the same thing is happening again just a few days into the New Year. Some of this is surely to do with the clumsy way that the Chinese authorities are interacting and communicating with the markets, trying but often failing to stabilise them.
Last year the situation righted itself eventually once the economic data showed that the Chinese data was not falling off a cliff.
This time some Chinese economic indicators have undoubtedly been soft, but others too have shown that far from collapsing, the Chinese economy is actually achieving something of a soft landing. Even though the Chinese manufacturing PMI indexes have been below the break-even level of 50 for much of the last year, which is deemed to be contractionary, this has not translated into overall growth falling significantly below 7 per cent. Furthermore, some of the currency weakness of last summer is now actually translating into more favourable export data, which shows that for all the noise the steps taken by the authorities to stimulate growth are actually beginning to work.
When it comes to oil prices as well, the connections that are being made about China’s growth prospects and their impact on oil prices do not always hold together either. For all of China’s growth woes last year, overall oil demand remained strong, with crude imports over the whole year up 8 to 9 per cent. Chinese SUV sales until November were also higher by 50.9 per cent, compared to the same period a year earlier. So the logic that says that weak Chinese growth spells trouble for oil demand, and by extension prices, appears misplaced.
This has not stopped oil prices from falling sharply since the start of the year, which probably tells us that the driving force for the current downdraft is also more about sentiment than a sudden change in the fundamentals of demand and supply, which are gradually improving. Oil prices now look to be entering a phase of undershooting, much as they overshot above US$100 per barrel. How long they remain in this phase remains uncertain, but while the immediate effect of lower oil prices might well be negative, without more fundamental justification the medium-term impact is still more likely to be positive for the global economy.
Finally, for all the focus on China and oil prices at the start of the year, for either wrong or right reasons, it should not be forgotten that the rest of the world economy is not actually preforming too badly.
Granted, emerging economies and commodity producers are being hit by these two factors the most, and these impacts can feed through equity markets to create negative feedback loops affecting the rest of the world. But in the developed world the US economy has started the year reasonably well, with jobs growth of 292,000 reported for last month, and Europe also appears to be holding up.
The bottom line is that sentiment and confidence are brittle to a large extent just because they are. Under the surface, the fundamentals have not changed an awful lot from a month ago.
Tim Fox is the chief economist and head of research at Emirates NBD.
business@thenational.ae
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