Summarising The Global Economy Today (10 October 2018)

Table of Content

Diagram
1. The US sanctions on Iran and Rising Oil Prices
2. Strong US Economic Data
2.1. PMI (Purchasing Managers’ Index)
2.2. ADP
2.3. The US Unemployment
3. Mounting Inflation Pressure
4. Fostering an Environment for Higher Interest Rate Expectations
5. Downward Pressure on the US Equity Market
6. Strengthening USD
7. The Strong US Dollar Pressures Ems
7.1. Indonesia
7.2. Turkey
8. The traditional US dollar and oil inverse relation broke down
9. The Market Correction
References

Preface:

In early October 2018, the global economy is as dynamic as ever and the relationships amongst (1) rising oil prices, (2) strong US economic data, (3) mounting inflation pressure, (4) higher interest rate expectation, (5) downward pressure on the US equity market, (6) the strong US dollar, and (7) its pressure on emerging markets can be summarised in the diagram below.

Diagram_2

1. The US Sanctions on Iran and Rising Oil Prices

Unilaterally pulling out of the Iran nuclear deal (JCPOA) in his trademark fashion in August 2018, the Trump Administration re-imposed the sanctions on Iran, demanding the country to fully give up their ballistic missiles and nuclear weapons programmes.[1]The sanctions will come into effect on November 5, 2018, which include Iran’s oil exports. The aftereffect of the sanctions in regard to oil is said to be the removal of oil as much as 2 million barrels a day from the market, equivalent to 2% of world supplies.[2]The largest exporter of oil in the Persian Gulf region and the third largest OPEC oil producer has the immense impact on the global oil market.[3]Although Saudi Arabia’s ability to make up the shortfall from Iran has been talked about, it might not be sufficient to fill the gap. The uncertainty and a growing concern as to the less supply of oil have been contributing to the recent rising prices of oil.[4](Fig.1)

The Joint Comprehensive Plan of Action (JCPOA), the seven-party Iran nuclear deal, was signed in 2015 amongst Russia, China, Germany, France, the UK, the EU, and the US, which aims at limiting Iran’s nuclear programme through foreign aids and in a verifiable manner in order for the country to cultivate a democracy, economic stability and political steadiness, paving the way towards denuclearisation.[5]Easing sanctions was a major inducement to nudge Tehran to sign the JCPOA under President Obama, therefore, the executive order signed by President Trump caused many EU leaders to express their sense of regret, as they regard the seven-party deal being the most effective arms control agreement of recent years.[6]In addition, Iran has, more or less, abided by the agreement thus far.

Nonetheless, it has been said that the Trump administration hopes the regime in Tehran to change, as the current regime leaders are abusing their power, marked by corruption and unfair concentration of wealth amongst them.[7]

In late September 2018, Brent Crude oil prices, a benchmark price for worldwide purchases of oil, shot up above $80 a barrel.[8]Since then, thanks to OPEC members, such as Saudi Arabia and Libya that have increased oil outputs and the OPEC forecast for the coming year that expects demand for crude oil to decline, oil prices have come back down.[9](Fig.1) However, there is still much upward pressure in the light of US sanctions on Iran to be brought into effect in the coming month.[10]

Fig.1: Brent Crude Oil

Source: Thomson Reuters. (2018, October, 11)
Unit Price (USD)

oil prices

In the light of the mid-term election, President Trump is certainly concerned about the high oil prices, which affect ordinary folks and their living expenses. Since many of them are ardent supporters of the president, the administration has urged other OPEC members and Russia to increase their oil outputs.[11] 

Also, in global contexts, the US sanctions on Iranian oil has affected a number of countries that import oil from Iran. China, for instance, is the biggest importer of Iranian oil, followed by India, and both countries have been affected by the sanctions.[12]

 

2. Strong US Economic Data

Meanwhile, the US economy appears to be stronger than ever, as major economic indicators suggest.[13]The annualised quarterly growth was above 4% so far this year, while unemployment is at its lowest since 1969.[14]PMI and ADP have also shown strong data.[15]

2.1. PMI (Purchasing Managers’ Index)

The Purchasing Managers’ Index (PMI) is an indicator of economic health for the manufacturing and service sectors. The PMI is compiled and released on a monthly basis by the Institute for Supply Management (ISM). The PMI is composed based on a monthly survey sent to senior executives at over 400 firms. The PMI consists of four major survey areas, such as: (1) new orders, (2) inventory levels, (3) production, (4) supplier deliveries, and (5) employment. The PMI provides information about current business conditions on the scale of 0-100%, and when the index is going up, a bullish stock market can be expected because of the likelihood of higher corporate profits. The PMI in September 2018 was 59.8%.[16]

2.2. ADP

The ADP National Employment Report is a monthly economic data, indicating levels of nonfarm private employment in the US.[17]According to the ADP report, private sector employment increased by 230,000 jobs in September 2018, following 168,000 and 211,000 in August and July respectively.[18]

2.3. The US Unemployment

Meanwhile, the US unemployment rate fell to 3.7% in September.[19]Given the average unemployment in the United States being 5.77% between 1948 and 2018, it is an impressively low rate. Indeed, it was the lowest jobless rate over the last 49 years since December of 1969 with the number of unemployed people down by 270,000 to 6 million.[20]

 

3. Rising Inflation Pressure

The rising oil prices inevitably push up the inflation rate as it increases the prices of goods. In response to that, the Fed has already raised interest rates multiple times this year, causing the value of US dollars to appreciate against other major currencies.[21]

4. Fostering an Environment for Higher Interest Rate Expectations

The rising inflation rate naturally leads to higher expectations of interest rate hikes. The Fed has been engaged in the prudent balancing act between not letting the domestic economy overheated and allowing the impressive growth to continue. The upside is that as the central bank hikes interest rates, it will allow more space to manoeuvre in the event of the next recession as the business cycle is entering the late stage.

5. The Downward pressure on the US Equity Market

As the interest rate is raised further, it effectively creates downward pressure on the equity market, which has been enjoying the longest bull market in the history, albeit the growth has been gradual in comparison to the steepest bull market in the early 1930s.[22]

6. Strengthening USD

Simultaneously, the US dollar has been strengthening, thanks to the Fed’s multiple rate hikes. Also, in response to rising oil prices as well as concerns surrounding the US-China trade war, investors around the world began to retreat more traditional safe havens, such as the US dollar.[23]

This is contrary to the traditionally established inverse relationship between the US dollar and oil prices. Nonetheless, unlike the downward trend shown at the beginning of 2018, since the summer of 2018, USD has been appreciating against other major currencies, as the US dollar index (DXY) shows (Fig.2).

 

Fig.2: U.S. Dollar Index (DXY) – US dollar against other major currencies

Source: MarketWatch (2018, October 12)

DXY

The strengthening USD also runs counter to Trump’s campaign to narrow the US trade deficit with China and Europe, as the strong dollar makes American products more expensive to foreign buyers, thereby causing it difficult to reduce the deficit.[24]

 

7. The Strong US Dollar Pressures EMs

More crucially, the stronger US dollar puts an enormous pressure upon already fragile markets, in particular, emerging markets (EMs). The rising US dollar can hurt the developing world in a few ways. First, their debts are often denominated in US dollars. EMs do not usually have developed local capital markets or plenty of domestic savings. As a result, their borrowing relies on foreign investors, and their debts are thus often denominated in foreign currency on a large scale, and in many cases, in USD. As such, strengthening USD means ballooning their debts.[25]If a nation is plagued with large dollar-denominated liabilities, in terms of their local currency value, a stronger dollar means catastrophic. Secondly, even though emerging markets are generally net exporters of commodities, with exceptions of China, India and Turkey,  when the value of the world reserve currency goes up, in which EMs’ debts are often denominated, the revenue from exports effectively diminishes.[26]

The third point is that a stronger dollar has a mixed impact upon economic growth in EMs. Whilst weaker local currencies stimulate exports in EMs in the short run, foreign direct investment (FDI) may be deterred, which is critical to medium-term growth. FDI is incentivised by growing local labour forces and consumption, whereas weakened local currencies and rising prices of import goods lead to inflation, weaker consumption, and less robust labour forces with dented animal spirit, which conversely de-incentivise FDI.

7.1. Indonesia

Southeast Asia’s largest economy, Indonesia, has been acutely susceptible to the strong USD. Now, the Indonesian Rupiah is traded around 15,000 to the US dollar, dropping by 10% overall this year, the weakest point in over 20 years since 1998, the Asian Financial Crisis.[27]

Indonesia runs a current account deficit. In July, it reached US$8.03 billion, the highest level in the past five years.[28]The central bank of Indonesia, Bank Indonesia (BI), has already increased the interest rate five times to the current 5.75% since May in a desperate attempt to stabilise the currency depreciation, and thanks to that, inflation seems to be now under control, down to an over-two-year low of 2.88% in September.[29]The governor of BI, Perry Warjiyo has expressed his sanguine view, confirming that the fundamentals of the domestic economy are fairly sound and in relation to its fundamentals, the Rupiah is undervalued, although exchange rates undoubtedly constitute the fundamentals.[30]

Other emerging markets, as geographically diverse as Turkey, India, Argentina and South Africa, have all experienced their currencies depreciated.[31]The likes of Turkey and Argentina are heavily reliant on foreign funding, such as the dollar-denominated one, hence, their sovereign debt structure has become a serious burden as a result of the strong USD.[32]This year, the Indian Rupee has fallen by 12%.[33]And to add to the list, the Pakistani rupee dropped by 10.2% to 137 against the US dollar in early October 2018.[34]Even China, which is no longer an emerging market, has nonetheless been affected by the strong USD immensely.

7.2. Turkey

Turkish Lira has depreciated in a dramatic fashion against USD, EUR and other major currencies. Investors have been increasingly anxious about Turkey’s ability to pay its dollar-denominated debts, which has contributed to the further weakening of Turkish Lira.[35]Exacerbated by the US sanctions and rising tariffs triggered by Turkey’s detention of Andrew Brunson, a US pastor, the Turkish economy has been in turmoil, however, the populist president Recep Tayyip Erdogan has been adamant about aggressive interest rate hikes.[36]Turkey is America’s sixth-biggest foreign supplier of steel. Shortly after being re-elected in June, autocratic President Erdogan appointed his son-in-law Berat Albayrak as treasury and finance minister, posing a threat to the independence of the Central Bank of the Republic of Turkey, which has thus far adopted a rather dovish stance as to rate hikes.[37]

This year, Turkish Lira has depreciated against USD, EUR, GBP and JPY among other major currencies, by 62%, 59%, 62% and 38% respectively by October.[38]USD against Turkish Lira reached an all-time high of 6.86 in August 2018, whereas a record low was seen at 0.01 as far back as December 1991.[39](Fig.3, Fig.4)

Fig.3: USD/TRY

Source: tradingeconomics.com / October interbank rate (Jan 2017 – Oct 2018)
USD:TRY2017-2018

Fig. 4: USD/TRY

Source: tradingeconomics.com / October interbank rate (1991 – 2018)

USD:TRY1991-2018

Due to the impact of the ongoing currency crisis, in September 2018, the Turkish consumer price inflation jumped to 24.52% year-on-year, reaching the highest level since August 2003.[40]Interest rates were raised by 625 bps on 13 September, although little effect has been observed as to slowing the rising inflation. An all-time high was 138.71% in May 1980, while an all-time low was in June 1968 at -4.01%. During the period of 1965-2018, the average inflation rate in Turkey has been 35.08%. (Fig.5, Fig.6)

Fig.5: Turkey Inflation Rate (1965-2018)

Source: tradingeconomics.com; Turkish Statistical Institute

Turkey Inflation Rate 1965-2018_2

Fig.6: Turkey Inflation Rate (2008-2018)

Source: tradingeconomics.com; Turkish Statistical Institute
Turkey Inflation Rate 2008-2018

 

8. The traditional US dollar and oil inverse relation broke down

The US dollar and oil have traditionally had an inverse relationship.[41]If the USD is strong when buying commodities, including oil, it can reduce oil prices. This, however, seems to have broken down temporarily, perhaps due to major economies, such as China, India and Turkey, being the significant importers of oil.

9. The Market Correction

The seismic market correction came on Wednesday 10 October 2018 after the IMF stated that the world economy would plateau and slashed its growth forecast for the first time in over 2 years, attributing the causes to be the escalating trade tensions between the US and China and mounting stresses in EMs.[42]The S&P 500 reached its lowest in three months, the DJIA fell by 2.2% (836 points) and the Nasdaq 100 Index tumbled over 4%.[43]

The correction on 10 October led President Trump to criticise the Fed for further hiking interest rates as an utter political manoeuvre in an attempt to preserve his credit for the strong equity market in the last couple of years.[44]As the popularity of his presidency largely depends on the strong US equity market, the president made a bitter comment about the Fed hiking interest rates, even though such a monetary policy has been known since late last year.  The Fed’s goal is to assist the continuation of the current outstanding US economic growth by raising interest rates just fast enough to prevent overheating but not so rapidly that it will choke off the growth.

References

  
Abi-Habib, M. (2018). Pakistan Seeks I,M.F. Bailout as Government Sends Mixed Messages. The New York Times. Available at: https://www.nytimes.com/2018/10/11/world/asia/pakistan-imf-bailout-imran-khan.html
ADP Research Institute. (2018). ADP National Employment Report. September 2018. Available at: https://www.adpemploymentreport.com/2018/September/NER/NER-September-2018.aspx
Bullock, N., & Fox, B. (2018, August 22). 3,453 days and $81tn later, the US bull market hits record run. Financial Times. Available at: https://www.ft.com/content/8c14f290-a588-11e8-926a-7342fe5e173f
Buncombe, A. (2018, August 6).Trump signs order reimposing sanctions on Iran – a move the EU said it ‘deeply’ regrets. Independent. Available at: https://www.independent.co.uk/news/world/americas/us-politics/iran-sanctions-trump-us-eu-nuclear-deal-trade-executive-order-latest-a8479806.html
DiChristopher, T. (2018). OPEC hikes oil output in September as Iran’s production falls, demand outlook softens. CNBC. Available at: https://www.cnbc.com/2018/10/11/opec-hikes-oil-output-in-september-as-irans-production-falls.html
Investopedia.com. (2018). The ISM Manufacturing Index. Available at: https://www.investopedia.com/terms/i/ism-mfg.asp
ISM. (2018). September 2018 Manufacturing ISM, “Report On Business” https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm?SSO=1 
Lash, H. (2018, October, 10). Global stocks slide to three-month low on tech stocks plunge, rising U.S. interest rates. Reuters. Available at: https://www.reuters.com/article/us-oil-conference-traders/worlds-t…raders-divided-on-oil-outlook-as-iran-sanctions-loom-idUSKCN1MK18S
Lynch, D.J. (2018, July 19). Trump criticizes Federal Reserve, breaking long-standing practice. The Washington Post. https://www.washingtonpost.com/business/2018/07/19/trump-criticizes-federal-reserve-breaking-long-standing-practice/?noredirect=on&utm_term=.dc0713e9828f
MarketWatch. (2018, Oct 12). U.S. Dollar Index (DXY). Available at: https://www.marketwatch.com/investing/index/dxy/charts
McCormack, J. (2018, May 15). Dollar strength and emerging market stress are inseparable: Financial Times. Available at: https://www.ft.com/content/44508d0e-5789-11e8-b8b2-d6ceb45fa9d0
Payne, J., & Zhdannikov, D. (2018). World’s top traders divided on oil outlook as Iran sanctions loom. Reuters. Available at: https://www.reuters.com/article/us-oil-conference-traders/worlds-top-traders-divided-on-oil-outlook-as-iran-sanctions-loom-idUSKCN1MK18S
Raval, A., & White, E. (2018, Sep 24). Oil climbs to 4-year high above $81 a barrel. Financial Times. Available at: https://www.ft.com/content/fc7ae0e4-bfc3-11e8-95b1-d36dfef1b89a
Resnick-Ault, J. (2018). Oil pares gains as Trump repeats calls on OPEC to pump more. Reuters. Available at: https://www.reuters.com/article/us-global-oil/oil-pares-gains-as-trump-repeats-calls-on-opec-to-pump-more-idUSKCN1M501Z
Rose, D.G. (2018, Oct 6). Rupiah at Lowest since Asian Financial Crisis, but Indonesia keeps calm and carries on. South China Morning Post. Available at: https://www.scmp.com/week-asia/economics/article/2167208/rupiah-lowest-asian-financial-crisis-indonesia-keeps-calm-and
Russ, H. (2018, Sep 25). Oil price above $80 lifts stocks, rate hikes expected. Reuters.
Sheppard, D. (2018). Leading oil traders face off over price outlook as Iran sanctions near. Financial Times. Available at: https://www.ft.com/content/82f37620-cc82-11e8-9fe5-24ad351828ab
Sink, J., & Pettypiece, S. (2018). After Stock Market Drop, President Trump Says Federal Reserve “Has Gone Crazy’. Time. Available at: http://time.com/5421358/trump-fed-stock-market-gone-crazy/
Tan, Weizhen. (2018, Sep 3). Indonesia’s Rupia falls to its weakest level in more than 20 years. CNBC. Available at: https://www.cnbc.com/2018/09/03/indonesia-rupiah-falls-to-weakest-level-in-more-than-20-years.html
Tankersley, J., Swanson, A., & Phillips, M. (2018). Trump Hits Turkey When It’s Down, Doubling Tariffs. The New York Times. Available at:https://www.nytimes.com/2018/08/10/us/politics/trump-turkey-tariffs-currency.html
Tappe, A. (2018, August 3). Here’s why there may be more pain in store for Turkey’s lira. MarketWatch. Available at:https://www.marketwatch.com/story/heres-why-there-may-be-more-pain-in-store-for-turkeys-lira-on-friday-2018-08-02
TradingEconomics. (2018a). United States Unemployment Rate 1948-2018. Available at: https://tradingeconomics.com/united-states/unemployment-rate
TradingEconomics. (2018b). Turkish Lira 1991-2018. Available at: https://tradingeconomics.com/turkey/currency
TradingEconomics. (2018c). Turkey Inflation Rate 1965-2018. Available at: https://tradingeconomics.com/turkey/inflation-cpi
TradingEconomics. (2018d). Indonesia Inflation Rate 1997-2018. Available at: https://tradingeconomics.com/indonesia/inflation-cpi

[1]Buncombe, 2018

[2]Sheppard, 2018

[3]Payne & Zhdannikov, 2018

[4]Sheppard, 2018

[5]Buncombe, 2018

[6]Buncombe, 2018

[7]Buncombe, 2018

[8]Raval & White, 2018

[9]DiChristopher, 2018

[10]Payne & Zhdannikov, 2018

[11]Raval & White, 2018; Russ, 2018; Resnick-Ault, 2018

[12]Buncombe, 2018

[13]Lash, 2018

[14]The Economist, 2018

[15]ISM, 2018

[16]ISM, 2018

[17]Investopedia, 2018

[18]ADP Research Institute, 2018

[19]Sink & Pettypiece, 2018

[20]TradingEconomics, 2018a

[21]Lynch, 2018

[22]Bullock & Fox, 2018

[23]Rose, 2018

[24]Lynch, 2018

[25]McCormack, 2018

[26]McCormack, 2018

[27]Tan, 2018

[28]Rose, 2018

[29]Rose, 2018; TradingEconomics, 2018d

[30]Rose, 2018; McCormack, 2018

[31]Rose, 2018

[32]Tappe, 2018

[33]Rose, 2018; The Economist, 2018; McCormack, 2018

[34]Abi-Habib, 2018

[35]Tankersley, Swanson & Phillips, 2018

[36]Tankersley, Swanson & Phillips, 2018

[37]Tappe, 2018

[38]TradingEconomics, 2018b

[39]TradingEconomics, 2018b

[40]TradingEconomics, 2018c

[41]Lash, 2018; McCormack, 2018

[42]Sink & Pettypiece, 2018

[43]Lash, 2018; Sink & Pettypiece, 2018

[44]Sink & Pettypiece, 2018

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