28 October 2016
Oil producers are unlikely to reach agreement on output cut, which could keep prices depressed in the near term. Photo: Xinhua
Oil producers are unlikely to reach agreement on output cut, which could keep prices depressed in the near term. Photo: Xinhua

Oil prices to remain key driver of market sentiment

Investors are turning more bearish about global growth prospects amid volatile financial markets and record-low oil prices. 

The 10-year treasury yield plunged to 1.828 percent on Wednesday, the lowest since April 2015. The US dollar could come under pressure, and capital will again flow to safe-haven assets.

Gold has benefited the most from the trend. The yellow metal has seen its price jump to US$1,130 an ounce with a 5.4 percent rise last month alone, the largest monthly rally in a year or so.

Investors have fled to precious metals as major central banks have maintained loose monetary policy, and central banks in Japan and European nations even adopted negative interest rate.

China’ official manufacturing PMI slumped to a three-and-a-half-year low in January, and non-manufacturing PMI also fell off last month. This suggests that the nation’s economy is continuing to struggle in the new year amid sluggish global growth.

The manufacturing sector will continue to suffer as Beijing tries to phase out excess capacity, which is one of the main tasks outlined for 2016 by the Central Economic Work Conference at the end of last year.

The overcapacity issue may not be tackled completely given China’s massive economic size. However, the “One Belt One Road” strategy may help mitigate the problem.

Meanwhile, the government may also unveil more easing measures as growth remains weak in the current quarter.

A prolonged slide in oil prices has reignited concerns over the global economy. That worry has prompted investors to close positions in rate arbitrage. That has hurt the Australian dollar and the New Zealand dollar.

The Australian dollar is likely to remain stable in the short term as the nation’s central bank has no imminent need to further cut interest rates anytime soon amid a set of encouraging economic data.

New jobs hit a nine-year high in that country last year, and non-mining sector growth, business confidence and company borrowing activities are all showing positive signs.

In the meantime, the market is less optimistic that oil producing nations will be able to reach an agreement for cutting production. A meeting between oil ministers of Russia and Venezuela has failed to yield any confirmed production cutback plan.

Oil exports are the main source of revenue for OPEC nations. The producers are struggling with widening fiscal deficits due to the oil price slide. Amid this difficult situation, it is doubtful if they will agree to reduce supply.

Crude oil price has tumbled as much as 75 percent over the last 18 months, due mainly to oversupply. Lackluster demand from emerging nations like China also weighed on the price.

However, producing nations are unlikely to agree on output cut. Saudi Arabia, one of the biggest OPEC members, has already struggled to reach an agreement with Iran. Negotiations with Russia and other non-OPEC members could be even harder.

Against this backdrop, oil prices might continue to hover near the bottom for a while. That will further stretch the fiscal position of oil exporters and deplete their foreign exchange reserves.

In fact, oil exporters like Azerbaijan and Nigeria have already start looking for external financial support. The market is keeping a close eye on who will be the next to seek assistance from the World Bank or the IMF.

Given this situation, we can be pretty sure that oil price will remain a key theme driving market sentiment in the near future.

This article appeared in the Hong Kong Economic Journal on Feb. 5.

Translation by Julie Zhu

[Chinese version 中文版]

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Senior investment strategist and vice president, treasury & markets division, DBS Bank (Hong Kong)

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