From the Morgan Stanley Dean Witter Economic Group:
Global: Managing Global Risk
Stephen Roach (from London)
World policy makers have stepped up to the plate. Recognizing that global risks were mounting, they have made a concerted effort to deal with two of the most volatile flashpoints -- currencies and oil. How successful are their efforts likely to be?
Of the two risk factors, I view oil as the greatest threat to the world economy. That’s not to minimize the potential gravity of a euro crisis. But the latest bout of foreign exchange volatility, in my view, was more of a financial market problem than an economic risk. If anything, a weak euro boosts the region’s exports, thereby cushioning the downside of any shortfall in economic activity. At the same time, our Euro team has stressed that the crisis was starting to raise serious questions about the political underpinnings of the entire EMU experiment. For that reason, alone, action was warranted.
Joachim Fels, our resident euro expert, believes that last week’s coordinated intervention will succeed in putting a floor under the beleaguered currency. I hope he’s right. For that to happen, either or both of the following conditions must be satisfied: There must be repeated coordinated intervention and/or it must be accompanied by a policy realignment within the G-3. I certainly wouldn’t rule out the possibility that the actions of 22 September won’t be repeated in the future. In their Prague communiqué released over the weekend, G-7 finance ministers left their options open on this point, stressing that "In light of recent developments, we will continue to monitor developments closely and to cooperate in exchange markets as appropriate." The second condition seems more problematic. In the face of an energy shock, the US Fed seems unlikely to ease monetary policy. And our euro-zone team sees, at most, only one additional monetary tightening of 25 bp by the ECB over the foreseeable future. The bottom line for currency risks: The recent excesses may have been contained by currency intervention. While there may now be a floor to the downside of the euro -- and a cap to the upside of the dollar -- this market manipulation does not point to a fundamental reversal in foreign exchange rates.
The oil issue is another matter altogether. In my view, the supply-demand imbalances are so extreme, that the release of one million barrels per day from America’s Strategic Petroleum Reserve is unlikely to make much of a difference. The US supply injection is a little larger than OPEC’s recent production hike of 800,000 barrels per day. While it is equivalent to about 7% of the daily oil usage by American oil refineries, it amounts to only about 1% of total global production. Moreover, unlike the OPEC initiative, the SPR release has a finite duration of 30 days; that’s enough to draw down fully 5% of America’s emergency stockpile of crude oil, a depletion that will have to be replaced in the not-so-distant future.
At best, in my view, this is the stuff of temporary price relief for crude oil prices. Supply increments do not come on stream instantaneously, and the US SPR release is not of the so-called sweet crude variety, which is needed for refining of gasoline. And that takes us to the biggest macro risk of all: Even if crude oil prices come down, product prices are not likely to follow. Nationwide refining capacity is already running at 95% of rated capacity, hardly the slack that would allow for a quick and easy restoration of the balance between supply and demand. That’s especially true of home heating oil, where inventories are running nearly 20% below year-earlier levels -- before the winter heating season has even begun. Nor will any relief in crude oil prices alleviate the imbalances that have pushed natural gas prices sharply higher over the past year.
The macro story for energy is all about product prices, not the price of crude oil. To the extent that crude oil prices serves as a good proxy for overall energy quotes, then a supply-induced decline in the price of the raw input would ease pressures in the broader energy complex. But that’s not the case today. Our energy and commodity teams have long stressed that product prices are likely to have much greater stickiness to the downside than are prices of crude oil. To the extent that we key our macro forecasts off the prices of the products that consumers and businesses actually use, then an energy-related hit on the global economy still seems like a distinct possibility to me. Our growth forecasts around the world remain under review for that very reason. Stay tuned. |
