2015 started with a bang and ended with a whimper. All the hope and triumph was replaced with muted anticipation of the unpredictable. The biggest news of 2015 has been the fall in crude oil prices, and unfortunately crude oil prices will be one of the three main themes of 2016 as well. The second being interest rates and third 'Chinese growth'.
After a hiatus of over nine years, the US Federal Bank raised interest rates by 25 basis points. Most analysts spent all of 2015 waiting for the rate hike and it only came towards the end of the year. This hike came with the announcement that the Fed would step up rates during 2016. On first reading it appeared that there would be a hike in every quarter of 2016. My view is that most likely there will be only two or a maximum of three hikes in 2016. And my reason for that is that growth is not strong enough to sustain these interest rate hikes. While the headline numbers for US economic activity are positive and indicate improving employment numbers,better housing market, higher car sales figures and relatively strong GDP numbers, it is important to pay attention to freight movement data, PMI, retail sales and consumer confidence as well, these numbers haven't been as good. Below the surface signs of an imminent slowdown are clear. Subsequent rate hikes may not be absorbed comfortably into the economy and may derail growth. The trouble that the Fed faces is that it has kept interest rates at zero for far too long. We cannot have an indefinite time horizon of a zero interest rate regime. This will and probably has already created asset valuation bubbles which will be harder to manage in the future. (Not saying that the current bubble will deflate easily). It's likely that we may see a cautious Fed raise rates twice in 2016, not because it wants to but because it has to.
Globally, the growth revival theme is beginning to unravel. Europe never really recovered from 2008-09, partly because of the inter-linkages of economies and partly because there just hasn't been growth in population to drive economic activity. China continues to remain a black hole in terms of data accuracy. We know lots is happening in China, but we don't know how much and when exactly! The creation of mammoth capacities in all industries is just unsustainable once Chinese domestic demand slows. This scenario of idling capacity and slowing growth in China is likely to play out in 2016. The repercussions of this will definitely jolt the globe, after-all the 'engine' is stalling.
Let's turn our attention to crude oil for a moment. It fell over 50% in 2015 and global oversupply was more than 1 million barrels of crude per day. 2015 also two seismic shifts; the US replaced Saudi Arabia as the worlds largest oil producer, and talks of lifting economic sanctions on Iran gained momentum. Most probably the sanctions will be lifted from Iran which would lead to an additional supply into the market. This coupled with increased production from Iraq and Libya will lead to an oversupply more than a 1.6 million barrels of crude per day. This will lead to a readjustment in prices (read lower) for the near future. The only way this impasse will resolve itself is by supply coming off. The high cost fields will necessarily need to shut down. Oil prices are unlikely to remain in the $20-30/barrel range for too long (not suggesting $100/bbl). At these oil prices economies will collapse and civil unrests will follow. No government will risk civil unrest, it usually ends badly for those in power. For now all producers are demonstrating a brave front, but it is a matter of time before they blink. I believe that by the end of the year we should see higher oil prices (~50/bbl range).
I do wish that 2016 is less grim than it is in my mind.
After a hiatus of over nine years, the US Federal Bank raised interest rates by 25 basis points. Most analysts spent all of 2015 waiting for the rate hike and it only came towards the end of the year. This hike came with the announcement that the Fed would step up rates during 2016. On first reading it appeared that there would be a hike in every quarter of 2016. My view is that most likely there will be only two or a maximum of three hikes in 2016. And my reason for that is that growth is not strong enough to sustain these interest rate hikes. While the headline numbers for US economic activity are positive and indicate improving employment numbers,better housing market, higher car sales figures and relatively strong GDP numbers, it is important to pay attention to freight movement data, PMI, retail sales and consumer confidence as well, these numbers haven't been as good. Below the surface signs of an imminent slowdown are clear. Subsequent rate hikes may not be absorbed comfortably into the economy and may derail growth. The trouble that the Fed faces is that it has kept interest rates at zero for far too long. We cannot have an indefinite time horizon of a zero interest rate regime. This will and probably has already created asset valuation bubbles which will be harder to manage in the future. (Not saying that the current bubble will deflate easily). It's likely that we may see a cautious Fed raise rates twice in 2016, not because it wants to but because it has to.
Globally, the growth revival theme is beginning to unravel. Europe never really recovered from 2008-09, partly because of the inter-linkages of economies and partly because there just hasn't been growth in population to drive economic activity. China continues to remain a black hole in terms of data accuracy. We know lots is happening in China, but we don't know how much and when exactly! The creation of mammoth capacities in all industries is just unsustainable once Chinese domestic demand slows. This scenario of idling capacity and slowing growth in China is likely to play out in 2016. The repercussions of this will definitely jolt the globe, after-all the 'engine' is stalling.
Let's turn our attention to crude oil for a moment. It fell over 50% in 2015 and global oversupply was more than 1 million barrels of crude per day. 2015 also two seismic shifts; the US replaced Saudi Arabia as the worlds largest oil producer, and talks of lifting economic sanctions on Iran gained momentum. Most probably the sanctions will be lifted from Iran which would lead to an additional supply into the market. This coupled with increased production from Iraq and Libya will lead to an oversupply more than a 1.6 million barrels of crude per day. This will lead to a readjustment in prices (read lower) for the near future. The only way this impasse will resolve itself is by supply coming off. The high cost fields will necessarily need to shut down. Oil prices are unlikely to remain in the $20-30/barrel range for too long (not suggesting $100/bbl). At these oil prices economies will collapse and civil unrests will follow. No government will risk civil unrest, it usually ends badly for those in power. For now all producers are demonstrating a brave front, but it is a matter of time before they blink. I believe that by the end of the year we should see higher oil prices (~50/bbl range).
I do wish that 2016 is less grim than it is in my mind.
3 comments:
Fed interest rate call was right..
http://www.cnbc.com/2016/03/16/fed-leaves-rates-unchanged.html
Oil call proved right.. Hit $52 in Oct..
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