Somebody laughing at Lawrence Summers for predicting that the US Federal Reserve’s next walk may be a tightening, more than weakening, is quite silent now.
Next month, the previous US Treasury Secretary made a very outlandish statement. Some Fed forecasts have probably been blown to pieces in the 48 time since Iran’s missiles struck Israel.
Additionally, the Organization of Petroleum Exporting Countries syndicate continues to impose a small cap on oil production, which has led Citigroup and others to anticipate US$ 100 per barrel oil on the horizon.
Together, all this suggests world inflation is likely to heat up as the year advances, dashing sure hope that prices may have peaked.
According to Citi scientist Max Layton, “what is not priced into the current market is a possible culmination of a strong conflict between Iran and Israel,” which we anticipate could see crude prices trade up to $ 100 per chamber, depending on the nature of the activities.”
That, in turn, reduces the odds of Fed rate cuts in ways that imperil Asia’s economic outlook in 2024.
“ In a worst-case scenario, a forceful retaliation by Israel could trigger a spiral of escalation, potentially leading to an unprecedented regional conflict, ” says Jorge Leon, senior vice president at Rystad Energy. “ Under such circumstances, geopolitical premiums would increase significantly. ”
This would quickly alter Southeast Asia’s economies, China, Japan, and South Korea’s calculus.
It’s not just crude oil, but also rising prices for other important commodities, including coffee and cocoa, from precious metals to precious metals. The price increases for copper, gold, and other products are particularly alarming in the context of asset markets.
Analysts at Goldman Sachs claim in a research note that any rise in oil prices that is based on higher geopolitical risks may be slowed down by oil producers choosing to hedge their price risks and sell forward their production.
As “significant input for many industries, ” Rebecca Babin, a top energy trader at CIBC Private Wealth, thinks “rising [commodity ] prices will start to hurt growth ” in corporate profits if higher prices are not able to be passed along to consumers.
At this point, though, no one really knows what they don’t know about decisions in Jerusalem or Tehran in the days ahead.
If the Israeli government follows the White House’s advice and forgoes retaliatory action, the war may escalate, says analyst Helima Croft at RBC Capital Markets.
Although Iranian action was “much more expansive than previous reprisals, ” it was still predetermined in advance. ”
There were indications that Fed Chairman Jerome Powell’s team would n’t be cutting rates several times in 2024 even before the weekend attack, which involved more than 300 missiles and drones.
In March, the consumer price index rose at a faster-than-forecast 3. 5 % annual rate. It’s difficult to see Fed officials, who previously resisted ease a week ago, agreeing to cut rates right now.
That is especially true given the low US unemployment rate of just 3. 8 %. According to Nationwide Mutual economist Kathy Bostjancic, it wo n’t be lost on the Fed that signs of full employment abound.
Those indicators include average weekly hours worked ticking up to 34. 4 from 34. 3 in February, and a 62 percent increase in labor force participation. 7 % from 62. 5 %.
Even so, the stakes would have skyrocketed should oil prices go up.
One would assume that the group would look to recoup some of this surplus capacity if prices were to significantly rise on the back of supply losses, according to Warren Patterson, ING Bank’s head of commodities strategy. Given the possibility of destroying demand, OPEC will not want to see prices go too high. ”
But, Patterson notes, “there’s still plenty of uncertainty and it all depends on how Israel now responds. ”
By ING’s numbers, Iran produces over 3 million barrels of crude oil per day, making it OPEC’s No 4 producer.
As such, Patterson notes, supply risks abound — from stringent oil sanctions and whether Israel’s response in the days ahead hits Iran’s energy infrastructure.
In Washington, US President Joe Biden’s team could try to deploy US strategic petroleum reserves once again. Even OPEC may be concerned about the consequences of allowing unabated oil prices rise.
Not everyone worries energy prices are about to explode, though. Stephen Innes, managing partner at SPI Asset Management, says “while the drone attack has grabbed headlines, its immediate impact on global markets, particularly oil prices and inflation concerns, may be subdued. ”
Innes adds that Iran’s response was executed with great precision and a limited lethal impact, suggesting a tactical strategy meant to minimize harm rather than exacerbate tensions. As a result, the ripple effects on the oil market, a key determinant of global inflation dynamics, are expected to be somewhat muted. ”
According to Innes, the bottom line is that” the situation is still fluid and likely to dominate for some time. ”
Regardless, fresh turmoil in the Middle East means the Fed will “adopt a more cautious approach ” when it comes to cutting rates, notes Neil Shearing, group chief economist at Capital Economics.
“We expect the first move in September, ” Shearing says. We believe that the European Central Bank and the Bank of England will both reduce in June, assuming that energy prices do n’t go up over the next month or so. ”
Shearing claims that Iran’s actions represent a “new and potentially significantly more dangerous phase in troubles in the region.” The main concern for the moment is how an increase in Gulf tensions will impact energy prices. Higher costs, he adds, “would complicate success in reducing inflation. ”
Summers is concerned about the potential impact of the upcoming Fed action on the currency to hit the monetary brakes. You must consider the possibility that the next rate change will be upward rather than downward, ” Summers told Bloomberg.
Whatever the Fed decides, it seems the “higher-for-longer ” era for US yields, one Asia entered 2024 convinced was over, will live on indefinitely. That’s dreadful news for Asia’s export-driven economies.
For China, the Fed’s delay in or complete lack of rate cuts could result in a stronger US dollar. That, in turn, could further reduce the People’s Bank of China ’s latitude to cut interest rates for fear of a falling yuan.
The PBOC might not want the exchange rate to fall, for a variety of reasons. For one, it might make it more difficult for property developers to pay off their offshore debt, increasing the likelihood of default.
Additionally, it might waste progress in boosting global confidence in the yuan. A sluggish yuan could also put Beijing on a collision course in the wake of a contentious US election on November 5.
Here, too, there’s great uncertainty about the trajectory of China ’s economy and how that, in turn, might impact Asian trade and oil prices more broadly.
According to analyst Herbert Crowther of Eurasia Group,” China’s role as the primary driver for new oil consumption globally has come under scrutiny.” The second-largest economy in the world has emerged from the pandemic with significant short-term and structural challenges that will affect its fuel needs in 2024 and beyond. ”
According to Crowther, China’s enormous and expanding construction sector and rising auto sales were the single biggest contributors to the rise in global oil demand. Beijing’s policymakers have frequently turned to infrastructure and the real estate sector to fuel rapid oil demand growth, which is largely fueled by middle distillates like diesel. ”
Meanwhile, Crowther adds, “a fast-growing middle-income population segment purchased millions of new cars every month – virtually all running on gasoline before China ’s electric vehicle boom. ”
Japan’s export-driven economy is hampered by the notion that US yields will remain significantly higher for a longer.
Japan entered 2024 with a growth rate of just 0.1 % on average. 4 % in the fourth quarter of 2023 following a 3. 3 % contraction in the July-September period. The yen ’s plunge to 1990 lows, meanwhile, has the Bank of Japan mulling rate hikes.
Uncertainty will almost certainly halt Governor Kazuo Ueda’s upcoming effort to normalize Japanese monetary policy. Ueda’s task is exacerbated by concerns that the continued high US rates may increase the risk of a policy mistake.
One worry is that medium-size US banks might come under pressure, Silicon Valley Bank-style. Another is that a persistent lack of credit may only add to the issues the commercial industry faces. property sector, post-Covid-19, sending financial shockwaves Asia’s way.
According to Desmond Lachman, an economist at the American Enterprise Institute think tank, the Fed is paying close attention to the “slow-motion train wreck ” that is currently occurring in the commercial real estate sector as more people work from home. Office prices are currently anticipated to drop by at least 40 % from their 2022 peak level as a result of this. ”
Along with high interest rates, Lachman points out that this raises questions about how property developers will be able to roll over the$ 930 billion in property loans that have fallen this year without undergoing significant debt restructuring. ”
“ Unfortunately, it would be an understatement to say that the banking system in general, and the regional banks in particular, are not in a good position to make large loan loss provisions for their real estate lending, ” he said.
Any unrest caused by the US banking system or credit markets in general could cause particular trouble for Southeast Asia‘s export-dependent economies.
In Indonesia, Malaysia, the Philippines, Thailand and Vietnam, continued tight US central bank policies that limit China ’s ability to stimulate growth are not what regional policymakers had in mind for 2024.
It suffices to say that the Fed rate-cut-driven year that Asia envisioned is shifting to a year in which US yields will remain steady, if not even higher. Consider one of the many possible ways things could turn around for a region at the forefront of unrealized policy expectations and US rate volatility.
Follow William Pesek on X, formerly Twitter, at @WilliamPesek