Global Economy Throwing Up Red Flags For Oil

Investors are feeling the most pessimistic about the health of the global economy in a decade, according to a survey from Bank of America Merrill Lynch.

The gloom is spreading, with a growing number of data points that point to risks for the economy. Fund managers surveyed by BofAML said they are holding onto cash instead of risking it in a frothy market, and 85 percent of them said that the economic expansion is in its late cycle. 38 percent of them said that they expect growth to slow over the next year, the highest share since November 2008, which was during the depths of the financial crisis.

The trouble is multiplying. Tech stocks look inflated. The Fed continues to hike interest rates, which is having ripple effects across the world. Borrowing costs are rising, making it more expensive not just for individuals, but for companies and entire governments. The strong dollar is putting pressure on emerging market governments and their currencies, making dollar-denominated debt painfully expensive. The currency turmoil is also making oil incredibly costly in certain emerging markets.

In fact, a whopping 31 percent of respondents in the BofAML survey said that the Fed’s rate tightening presenting the biggest tail risk to the economy, although the U.S.-China trade war still looms larger.

Lower prices for agricultural goods and metals are dragging down profits in those sectors. China’s GDP has slowed amid trade pressure and things may only get worse as the previous round of U.S. tariffs on $200 billion worth of Chinese goods rises from 10 percent to 25 percent at the end of this year. Beyond that, U.S. President Donald Trump has threatened more tariffs on an additional $267 billion worth of goods.

The trade war “looks like it’s going to be a long-lived annoyance to the global economy and commodities producers need to get used to a few more years of slower-than-anticipated demand and tepid market sentiment,” Rory Johnston, a commodity economist at Scotiabank, wrote in a note. “We expect US tariffs on $250B in Chinese goods to remain in place at a rate of 25% through to the 2020 US presidential election, presenting broad but relatively mild headwinds to the Chinese economy.”

Then there is a mountain of debt held by China’s local governments. “The potential amount of debt is an iceberg with titanic credit risks,” S&P credit analysts led by Gloria Lu wrote in a report Tuesday. The debt situation at the local level has apparently grown worse as the national economy has slowed.

Worryingly, the U.S. housing market is also throwing up red flags. Higher interest rates are pushing certain homes out of reach for much of the middle class. As Bloomberg Opinion notes, home prices have grown much faster than incomes, which means that housing was already becoming more expensive before taking into account the Fed hiking interest rates. Home price growth is already in a cyclical downturn. Sales are declining and consumer sentiment is at its worst extent since 2008.

“Other downside risks cited included the possibility of a significant weakening in the housing sector, a sharp increase in oil prices, or a severe slowdown in EMEs,” the minutes of the Federal Reserve’s Open Market Committee meeting on July 31 and August 1 read.

The head of the IMF, Christine Lagarde, warned last week about some of the threats to the global economy. Economic growth is “uneven,” and emerging markets are in a dangerous position. “With global and public debt, private and public, at an all?time high, any slight change in the wind could provoke capital outflows and economic instability in emerging markets, as we see in some of those markets,” she said.

The potential slowdown in the global economy poses downside risks to oil prices. Last week, the IEA lowered its projection for oil demand, lowering it to 1.3 mb/d for both 2018 and 2019, down from a previous forecast of 1.4 mb/d. “This is due to a weaker economic outlook, trade concerns, higher oil
prices and a revision to Chinese data,” the IEA said.

But as the stormy clouds start to form over the global economy, a more serious downturn is not an impossibility. If such a downturn occurs, the IEA would have to make a lot more downward revisions to its demand figures.

By Nick Cunningham of Oilprice.com