Oil prices will not reach US$120, more U.S. Fed rate hikes expected, and Brexit’s fallout to remain largely within Europe
2018 is shaping up to be an interesting year in economics. Crude oil prices are at three-year highs, stock markets are on a roller coaster ride, and the U.S. Federal Reserve welcomes a new Chairman. What does this all mean for the global economy? Perspectives@SMU posed these questions to Simon Baptist, Global Chief Economist of The Economist Intelligence Unit.
NB: This interview was conducted on Feb 5, 2018, before U.S. stock markets opened and subsequently concluded with the Dow Jones Industrial Average losing 1175 points at closing.
Perspectives@SMU: With oil prices now at their highest point in three years. Are fundamentals pointing to a repeat of $120/barrel days? And what does that mean for the global economy?
Simon Baptist: I think there’s very little chance of oil going back to US$120 a barrel. In fact, I think the current prices of US$70 are a little high. My feeling regarding the fundamentals of the long-term price of oil in the next 12 to 18 months is that it will be between US$50 to US$65 a barrel.
The big reason why this has happened is that the U.S. has become such a big oil producer. U.S. oil production is quite responsive to price. When prices go up, you see U.S. producers increase output, and when the prices decrease you see U.S. production decrease in response to market forces. It’s a different dynamic to the past where price formation was more fully controlled by the OPEC countries – led by Saudi Arabia – which make decisions about output somewhat independently of the price. Decisions are made by the governments about how they want to affect the global market; they’re not responses to the market price.
U.S. production, which is now significant, is a response to the market price. That response will keep prices in a narrower band than before.
P: How much of that is affected by the shale producers? Are they back in the game now that prices are creeping up?
SB: Absolutely. It’s all about the shale producers. They are more easily able to respond to price changes and we are now seeing that. U.S. oil output has just reached its record level ever, surpassing any historical level of output. It’s in direct response to the fact that prices over the last six to eight months have been going back up, and oil producers have been increasing output.
P: Is oversupply likely as a result?
SB: It’s a bit difficult to talk about over- or under-supply. Oil, like any product, is just a market. There’s a demand and supply, and the price will just move and these things will find a balance.
What I do think will happen is that the increased production from the U.S. is going to put downward pressure on oil prices over the following six months as the increased production comes through. The shale producers in the U.S. must make sure they don’t invest so much in new production that prices will fall so much that they stop making money.
P: Jerome Powell is likely to maintain the course of slow Fed rate increases under Janet Yellen. What does that mean to the rest of the world and, specifically, Southeast Asia?
SB: The new U.S. Fed is a bit more hawkish than the previous one. They are more likely to prefer higher interest rates and lower levels of inflation than lower interest rates and higher levels of inflation. The new Fed is going to be less worried about unemployment than the previous one, and more worried about inflation.
I wouldn’t want to overstate that difference – it’s just a shift in emphasis. The latest Fed statement, when it came out, was a little bit more hawkish but not a lot. We still expect three rate rises from the Fed in 2019. And next year, maybe instead of expecting two or three rate hikes like we had under Yellen, we might now expect three or four.
The long-term perspective on U.S. interest rates is that they are still pretty low but the normalisation process, which has already started as Yellen has signalled, is likely to continue. But low unemployment and rising government spending means that barriers to raising interest rates are lower than in 2017.
What does that all mean for Southeast Asia? There might potentially be some downward pressure of currencies as those high interest rates induce people to put money into the U.S. rather than elsewhere. Also, countries with big current account deficits, such as Indonesia, will have to conscious about their domestic policy settings to make sure that they are attractive places for foreign direct investment which is harder to move around rather than investment in the stock market or bond market that can be shifted out and cause instability.
P: Stock markets have been on a bull run. Is a correction due? Do central banks and governments have the tools to control the fallout?
SB: Asset bubbles are something the world has to be wary about at the moment. It’s not just in the stock markets where there has been a big uptick in prices of assets. Many property markets have risen a lot in the last five years or so, so have stock and bond markets.
I do think the U.S. stock market is overvalued at the moment. The question you have to ask about the U.S. stock market is: Do you think U.S. tech companies are fundamentally changing the way we do business? And do you think those U.S. tech stocks are the companies who are going to reap future profits from that? Is the world going to use Amazon the way U.S. consumers use Amazon today? If you do, then you think all sorts of supermarket and retail businesses are going to go bust, and Amazon is going to get all the profits, for example.
In this region, perhaps it’s Alibaba who’s going to be that company, perhaps Baidu, or maybe Lazada or some other regional firm. If so, we might think U.S. stocks are a little bit stretched.
P: Is 2018 the year of the cryptocurrency crash?
SB: Like most economists, I’m currently a little sceptical about cryptocurrencies. But it’s our nature to be sceptical about something that challenges a fundamental unit of economy such as money, which has been running for such a long time. Money is only useful to the extent that other people accept it. Money has no value in and of itself. The paper or plastic of which it is made is worth nothing, but it’s worth something because the next person you give it to is going to accept it.
Therein lies the big challenge for bitcoin. I can see bitcoin, or cryptocurrencies in general, having uses in illegal transactions. Or where there is a need for some kind of secrecy desired by those taking part in the transaction. Or perhaps as in the case of China where people want to get around capital controls – it’s an unofficial way of moving money in and out of the country. So that provides a base for cryptocurrency usage.
But I don’t think governments are going to sit back and allow cryptocurrencies to take over the role of normal money. Governments do have the power to regulate these sorts of things. The supporters of cryptocurrencies say they are beyond governments’ influence, but that’s just because governments haven’t regulated cryptocurrencies yet. When governments see cryptocurrencies eroding their ability to raise tax, for example, I think they will intervene fairly quickly.
P: Is the tipping point close?
SB: I think it is close. A lot of regulators are talking about cryptocurrencies as a top priority. Another thing that could happen is national governments could launch their own cryptocurrencies (Editor's note: Venezuela launched the Petro on Feb 20, 2018, two weeks after this interview was conducted). You might say there are some benefits from blockchain technology that underlies those cryptocurrencies that could also be used by central banks and national governments themselves. If those benefits are real, then we will see governments setting up cryptocurrencies.
P: How significantly will Brexit affect global growth prospects for 2018? Will the associated issues - trade, immigration, finance – cast a wider shadow on EU reforms?
SB: Brexit is affecting the U.K. economy already. Now, Brexit is affecting it by less than most economists expected after the vote happened. I also expected to have a more negative impact immediately.
One of the reasons the British economy did well was that the currency crashed. U.K. exports became a lot cheaper, which helped the manufacturing sector. Also, the rest of Europe ironically had a good couple of years – there was a notable turnaround in France – and the rest of Europe is the biggest market for U.K. exports. Those two factors have come together. Additionally, consumer and business sentiment have held up pretty strongly after Brexit.
I think the change for this year is that now businesses are getting a bit more worried. We’re only one year out from when the date of exit has to happen on the current timetable and there is still no deal, not even a proper proposal. Businesses are holding off on some investments and waiting until things become a little clearer. But that all mainly affects the U.K. I don’t think it has global ramifications at this point.
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Last updated on 28 Feb 2018 .
