Trade tensions and uncertain geopolitics continue to be the main drivers of the markets, causing interest rates to sink and oil prices to gyrate. Policy meetings in the next two weeks at the Federal Reserve and Opec may succeed in calming some of these extreme moves, but for how long is uncertain.
Markets have begun to price in significant easing from the Fed this year, owing much to the unpredictable nature of Donald Trump's tariff policy disrupting global supply chains and creating business uncertainty. Comments from the Fed show they are increasingly sensitive to the downside economic risks associated with this, and could be poised to start easing monetary policy soon.
The comments also show a Fed under pressure from the White House to cut rates, a factor that in the end could hold them back from doing so. Ahead of last Friday’s US retail sales and industrial production reports, markets were pricing in a near 90 per cent probability of a rate cut at or before July, with more to follow over the rest of the year. However, in the wake of stronger than expected data, which saw sales rise by 0.5 per cent and production by 0.4 per cent, this is unlikely to happen at this week’s Federal Open Market Committee meeting with September probably being the earliest a rate cut might be countenanced.
The committee meeting this week will, however, see the Fed becoming more dovish, with the new dot plot projections expected to show no change in the target rate in either 2019 or 2020, versus a prior assumption of a quarter point hike in 2020. Some estimates may also show some officials favouring a rate cut this year. So, the pause in easing expectations will probably only be temporary, with any failure at the upcoming G20 meeting to conclude a trade deal between the US and China likely to quickly bring downside economic risks back into focus and rate cuts back on the agenda.
These downside economic risks have also been responsible for oil prices wilting from the year’s highs seen at the end of April. Brent is now nearly 17 per cent lower than its year-to-date peak of $74.57 (Dh273.9) per barrel while West Texas Intermediate is officially in a bear market, having fallen 20.8 per cent from its peak of $66.30 per barrel.
All major forecasting agencies lowered their demand projections for 2019 last week as the US Energy Information Administration, Opec and the International Energy Agency pointed to the uncertain impact a global trade war will have on commodity demand. Oil demand normally picks up in the second half of the year on seasonal factors, but with a highly uncertain outlook for trade relations between the US and China it’s doubtful there will be a significant boost in consumption.
It was not just trade tensions that caused oil prices to gyrate; oil markets experienced competing forces, as anxiety over global demand conditions at the start of the week vied with elevated geopolitical risks toward the end of it on news that two tankers were damaged in the Gulf of Oman, just outside of the Strait of Hormuz.
Elevated geopolitical tensions in the Middle East won’t help investor confidence and the perceived risk to crude supply coming out of the region will be a focus for Opec+ next week as it decides whether or not to maintain production cuts in the second half of the year.
It seems likely there will be a roll-over of the existing Opec+ production cuts aimed at keeping prices steady but going forward compliance with that deal could start to wane, seeing prices become less anchored and more volatile. First, heightened geopolitical risk will give a boost to oil prices that may be too tempting for exporters to resist. Second, Opec producers, particularly major ones like Saudi Arabia and the UAE, may want to reassure buyers over the availability of their crude exports at a time when alternatives are readily available.
Both the Fed and Opec are approaching key policy meetings at which measured messages appear to be the likeliest outcome aimed at calming markets to some extent. However, in the context of heightening trade and geopolitical tensions there is probably a limit to how much impact such messages can ultimately have.
Tim Fox is chief economist and head of research at Emirates NBD