Baku. 16 July. REPORT.AZ/ The market nervously awaits confirmation from the US Federal Reserve about whether they will start to raise interest rates, with Fed official Jerome Powell recently saying he saw potential for a September interest rate hike and another hike in December on the expectation that US economic growth will remain strong supported by a rise in inflation and continuous improvements in the job market. The Federal Reserve also signaled that the US economy is nearly ready to stand on its own but sought to assure investors that the process would be gradual, Report informs, Ole Hansen, Head of Commodities Strategy of Saxo Bank says.
However, a double rate hike in 2015 is not the view of my colleague, Chief Economist Steen Jakobsen, who expects the Fed will take a “minimum paid” approach in the form of a “one and done” rate rise in September. He says that if this approach is taken the dollar will weaken as the market sees the Fed as being done for now and this will be supported by a rising marginal cost of capital which will kill the nascent acceleration of growth expected by the consensus in H2 2015.
According to him, importantly for Azerbaijan’s economy, if there is only one interest rate hike, we will then expect commodities and gold/silver to outperform as asset classes. There has been substantial oil price sensitivity in the past few months and this is expected to continue into Q3 and Q4. While Opec is hoping over the coming months and into next year that US production will continue to slow and that a continued rise in global demand will eventually allow the price to move higher there are no guarantees that this will be the case.
The US dollar’s strength also matters for oil’s price recovery, because it can dramatically affect the price that non-US buyers must pay without the dollar price of oil moving.
Two rises in US interest rates by the end of 2015 could negatively impact oil prices considering the potential positive impact such an event would have on the value of the dollar. Commodities priced in dollars tend to be negatively correlated to the dollar. Rising US interest rates on the other hand would be a sign of an improving US economy and this could ultimately lead to stronger demand for crude oil towards gasoline production, just like we have witnessed during the past three months.
One of the basic theories proposes that rising or high interest rates help strengthen the dollar against other countries' currencies. When the dollar is strong, this helps American oil companies to buy more oil with every US dollar spent, ultimately passing the savings on to consumers.
O.Hansen says, Another theory stipulates that increasing interest rates raises consumer and manufacturing costs, which, in turn, reduces the amount of time and money people spend driving. Less people on the road translates to less demand for oil, which can cause oil prices to drop.
There is not anything petroleum exporting countries such as Azerbaijancan do to avert or minimize the risk caused by Fed decision. It is not a parameter they use when deciding production levels. However, market participants should always stay vigilant in case of volatile conditions.
Recently, The World Bank joined the IMF in urging the Federal Reserve to hold off raising rates until next year, citing an uneven US recovery and the risks to emerging markets of tightening policy any sooner. They state that a premature move by the Fed could cause the dollar to strengthen, which may slow the US economy and sideswipe emerging and developing countries. The key factor for decision making will be the economic situation in the US: The Fed will trigger hit the bottom when they feel the time is right based on developments in US labor market and inflation data. Outside developments such as Greece and the level of the dollar may also play its part but ultimately they will look towards their own economy.
Rising interest rates will tend to put the most pressure on those countries with significant external imbalances. Emerging market countries with big current account deficits have been and will be negatively exposed to rising US rates. However, it is worth noting that Azerbaijan recorded a current account surplus of 9.1 billion manats in September2014.While there is no threat for Azerbaijan from external imbalances, the decision by the US Federal Reserve will be significant for the Azerbaijan economy and market participants should be prepared ahead of the possible decision in September.