As Oil Sinks, Fed Hike Hurts Saudis
For Saudi Arabia and oil-producing countries in the Gulf of Arabia, having a dollar-pegged economy is a struggle as crude prices tumble and domestic deficits build.
The iShares MSCI Saudi Arabia Capped exchange-traded fund (KSA) is flat today, while the WisdomTree Middle East Dividend Fund (GULF) is down 0.2% and the Market Vectors Gulf States Index ETF (MES) is up 0.5%. The iShares MSCI Emerging Markets ETF (EEM) is down 0.6% today.
As the U.S. Federal Reserve raised its benchmark interest rate Wednesday, the official daily oil price benchmark for the Organization of the Petroleum Exporting Countries (OPEC) fell to a new 11 year low of $32.33 per barrel. Low oil prices are hurting the Saudi Arabian economy, where the overnight 90-day lending rate rose 10 basis points Thursday to 137.125 basis point, writes Marketfield’s Michael Shaoul. He adds:
“This is the highest this key funding rate has been since January 2009 and 60 bp above the level in place in mid July when the OPEC oil benchmark was still above $40. The Saudi Arabian benchmark is now 83.9 basis points above the US equivalent, an unusual state of affairs for a pegged currency, … although this is still well below the peak dislocation seen during the 2008 financial crisis when it reached 195 basis points … The problem for Saudi Arabia is that its monetary cycle is now counter-cyclical to the key driver of its economy. At least in 2008 the Federal Reserve Open Market Committee was slashing interest rates and injecting liquidity at the same time that crude oil was plummeting below $40. This time the FOMC has started to raise rates, and to do so drain liquidity via reverse repos, and this can only be viewed as a negative force for Saudi Arabia and other Gulf economies.
Although we believe the dangers to emerging markets in general from FOMC hikes has been overstated, for those maintaining pegged currencies underpinned by collapsing energy prices, the experience of 1994 remains valid:. Currency pegs then effectively transmitted Greenspan’s series of rate hikes to emerging market economies that were themselves entering domestic recessions, before the Peso crisis brought about the emergency intervention by the US Treasury and sudden reversal of monetary policy. For most of emerging markets, the direct linkage to U.S. monetary policy is now broken (although the effects on currency values and investor flows remain key drivers of local markets).”
See our posts “OPEC Raises Ceiling, Oil Falls As Venezuela Sends SOS” and “If Saudis Devalue Currency: Biggest Risk for Oil?”