Citi: 'We Should All Fear Oilmageddon'
Markets are currently in a well-oiled "death spiral," according to
Citigroup Inc. analysts led by Jonathan Stubbs.
"It appears that four inter-linked phenomena are driving a negative
feedback loop in the global economy and across financial markets," the
analysts write, citing the resilient U.S. dollar, lower commodities
prices, weaker trade and capital flows, and declining emerging market
growth.
"It seems reasonable to assume that another year of extreme moves in
U.S. dollar (higher) and oil/commodity prices (lower) would likely
continue to drive this negative feedback loop and make it very difficult
for policy makers in emerging markets and developing markets to
fight disinflationary forces and intercept downside risks," the analysts
add. "Corporate profits and equity markets would also likely suffer
further downside risk in this scenario of Oilmageddon."
Their case is bolstered by a collection of charts showing the
linkages between the four factors cited above, including the importance
of lofty oil prices to the ready supply of petrodollars circulating in
the world economy and flowing to financial assets. Oil exporters have
enjoyed more than $6 trillion flowing into their current accounts,
according to Citi's estimates, implying some $4 trillion of capital in
sovereign wealth funds (SWFs).
"But, the collapse in oil/commodity prices and sharp fall in the pace
of world trade means that these same economies will likely experience an
aggregate current account deficit for the first time since 1998," says
Citi. "In turn, this is likely to put pressure on SWF and broader
emerging market liquidity as governments and emerging market economies
would need to 'lean' on reserves in order to maintain
economic, political and social stability. This has clear feedback loops
across emerging markets."
Accordingly, the impact of the feedback loop is being felt far
and wide in financial markets, extending even to U.S. inflation
expectations. Where once 10-year inflation breakevens had little
relationship with the price of oil they have for the past two years
moved in tandem. With house forecasts for a 4 percent strengthening
of the trade- weighted U.S. dollar and oil prices at $50 by the end
of the year, Citi offers some hope that the feedback loop can be
partially reversed though not necessarily broken. Should the bank's
base case of stabilizing currency and commodities markets
materialize, the analysts say, financial assets should respond
accordingly and recover.
However, a move "the other way would add fuel to a 'significant
and syncronised' global recession," the bank warns warns.
"We should all fear Oilmageddon," Citi concludes. "Global
recession, as we define it, would leave nowhere to hide in equities.
Cash wins."
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