RIYADH, 25 October 2004 — There were hardly any new market-moving economic news or events last week to report.
Record oil prices remain the main story, but it is hardly a new story. For almost a month now, US crude oil prices have been above $50 a barrel and rising inexorably toward the next key level, $60 a barrel. In recent weeks, it has begun to weigh more heavily on the dollar and on global economic recovery. Long-term treasury yields, a barometer of market expectations of economic prospects, have been on the decline.
Markets are more and more pricing in a slowdown in the US economy. The result has been a significant flattening of yield curves. Since March, the spread between 10-year and 2-year US treasuries have fallen from 225 bps to 154 bps. On the lower end, the spread between the 2-year Treasury and the three-month T-bill has halved from 150 bps in April to 75 bps now.
Concerns are beginning to emerge that the US Fed may have tightened interest rates too much too soon (three raises totaling 75 bps). Thus, markets clung quickly to the comments by Philadelphia Fed president, Anthony Santomero, that the central bank may slow the pace of interest rate hikes if the US economy showed serious signs of weakening. In our last week’s commentary, we observed that high oil prices are beginning to bite.
Analysts are cutting back their forecasts of economic growth in the US, Japan and the euro zone. We are not sanguine about the rest of this year because of five factors. The November US presidential election, the January Iraq election, the upcoming winter heating season, oil supply bottlenecks and shortages around the world and a lack of spare capacity means that oil prices will remain high or go even higher by the end of this year.
In a curious twist, OPEC has not only become irrelevant to the oil price equation, but it finds itself in a dilemma. If it does not raise oil production then oil prices rise; if it raises production, prices rise anyway because markets get worried about the lack of spare capacity. What has to happen to loosen the stranglehold of high oil prices in the medium-term is for oil demand to fall. Signs are emerging that this maybe beginning to happen.
Last week, both the International Energy Agency (IEA) and OPEC cut their oil demand forecast for next year by 70,000 bpd and 130,000 bpd, respectively, due to the higher oil prices. The problem is that in the process of cutting oil demand, high oil prices are also cutting on global economic growth. This is one of the key things battering markets now. Domestically, the Saudi stock market set yet another record, closing at 6,950 last week, up 4.3 percent over the week and 56.6 percent year-to-date. The market is being driven by record liquidity, record corporate profits and heavy trading. As long as oil prices remain high, this is likely to continue.
Companies that are thinking of listing their shares should do so now when the market is hot as they can walk away with a handsome gain. Good news for Etisalat.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
