LONDON 8 NOV 2014: A falling oil price could hamper rather than aid economic recovery as lower export revenues for energy producers will mean fewer petrodollars propping up markets and keeping a lid on the cost of capital.
Research by BNP Paribas published this week found energy exporting countries are set to pull more money out of world markets than they put in for the first time in almost two decades.
This, BNP said, amounts to less liquidity in financial markets — effectively less money chasing assets and propping up prices which, in turn, potentially means a higher cost of capital and weaker market prices.
Many investors expect this to contribute to upwards pressure on real interest rates in the United States.
According to US government data, members of the oil exporters club OPEC are the fourth largest foreign owner of US Treasury bonds, holding $268 billion, which makes them a key pillar of demand.
“Oil producers were exporters of savings. Most of that money, at least what was put in FX reserves and Sovereign Wealth Funds, went to US Treasuries,” said David Spegel of BNP.
“… with less incremental annual demand for US Treasuries… yields would not have as much support and would more easily move higher.”
Some investors say the withdrawal of liquidity could mean real rates rise elsewhere too, hurting less robust economies than the United States, such as Europe’s.
“America deserves higher real interest rates because unemployment is down, the economy is happier than most. Somewhere like Europe where they’re really not ready for higher real interest rates, it could be very painful,” said Charles Morris, of HSBC Global Asset Management.
Maarten-Jan Bakkum, emerging markets equity strategist at ING Investment Management says fewer petrodollars will exacerbate an existing trend of declining global market liquidity already set in motion by a slowing China.
HEADWIND FOR EMERGING MARKETS
Most likely to feel the impact are emerging markets dependent on foreign capital, such as South Africa and Turkey, he said, which are already seeing their currencies fall as investors move money out in search of the potentially higher yields on offer in the US if rates rise there.
“You can quantify global liquidity by looking at foreign exchange reserves and there we have seen deterioration and that’s likely to continue which means capital flows to emerging markets are less supported than they were. This is a longer term headwind for these markets,” Bakkum said.
The rate of increase in total reserves held around the world has slowed since 2009, from 16 per cent to just 2 per cent in 2013, according to World Bank data.
The impact could also be felt on stock markets.
Sovereign wealth funds, many of which are based on commodity export revenues including oil and gas, already feature prominently on the shareholder registers of many of the world’s largest companies.
Norway’s $890 billion oil fund owns 1.3 per cent of all global shares, for example.
These funds are also a major force in deal making. Sovereign funds spent $24.5 billion on mergers and acquisitions in the first half of 2014, the most in any six-month period since 2010, according to Thomson Reuters data.
A withdrawal of oil money would consequently have potentially far reaching consequences on company valuations.
However, some investors argue that a meaningful impact on asset prices from a withdrawal of liquidity related to falling oil prices is not imminent, partly because central banks can compensate with stimulus measures, at least for now.
Andrew Milligan, Head of Global Strategy at British fund manager Standard Life Investments said moves towards monetary easing by the Bank of Japan and the European Central Bank demonstrate this ability.
“You could argue that the fall in oil prices has caused a potential risk of a reduction of liquidity in international capital markets.
“And two central banks have stepped up to the plate already,” he said, noting that the banks framed their actions in terms of controlling inflation, rather than affecting international capital markets.
“(They) said: ‘This is a risk we have to be wary of … and we’re responding’.”
Source: The Econimic Times