RIYADH, 9 August 2004 — Investors are still hesitant or, should it be said, reluctant to believe fully in the economic recovery. Previous week brought strong signs that the US as well as the global economy was on a strong mend and expectations of a 25bps rate hike in the US was assumed to be normal. However, things have changed significantly last week. Over the week the assumed economic recovery met some bumps.
Oil prices skyrocketed last week and forced investors to abandon hopes of a recovery. Expectations of lower supplies at that time when demand keeps growing caused big ripples in the markets. Last week oil prices reached their highest ever in the world markets. It seems more speculative rather than demand-driven although demand is a strong factor. A buying spree was triggered last week as OPEC, with the only spare capacity, indicated that its taps were at full flow and more could only obtained by further development. Most of the OPEC members are pumping to their limits with the only spare capacity remaining with Saudi Arabia.
A senior official of the organization said that more could not be pumped at once but the group is working to expand its spare capacity by another 2.5 million barrels per day by the end of the year. To add insult to injury, the Russian government halted the bank accounts and operations of Yukos, its troubled oil company, which pumps 1.7 million bpd or 2 percent of global production, in addition to a fire in the US third largest refinery which further decreased the oil flow.
This was enough to rattle the markets. Global stock markets caved in on this news while treasury yields gasped for air as they sank further. Still expectations of a global recovery remained as the markets anxiously awaited the backbone of the US recovery: employment numbers. After months of excellent performance, the US economy had done enough. From an expected 228,000 jobs in July, a meager 32,000 were created while June’s number was also revised down. That was it. Global stock markets fell and on Friday, the Dow dropped 147 points after losing 163 points on Thursday. NASDAQ gave up 44 points following a 33 points fall on Thursday. Nikkei fell 88 points on Friday but its delayed effect will not be seen until Monday. FTSE gave up 76 points while the German DAX lost 2 percent of its value.
The non-farm payroll number turned out to be the underlying link connecting investor’s optimism and economic recovery, as investors abandoned risky assets expecting a downturn in the economy. The Fed meets next week to decide on interest rates. Although it earlier indicated a 25 bps hike, this turn of events makes it confusing. Investors lifted fixed income prices expecting no rate hike while it will depend on the Fed’s analysis of events whether rates actually go up or not.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
