Three months ago, we wrote "
How The Petrodollar Quietly Died, And Nobody
Noticed", in which we explained in painful detail why far from
the simple macroeconomic dogma which immediately prompted the macro
tourists to scream that "
oil prices dropping are good for US consumers", the
collapse in the price of crude is not only a disaster for oil
exporting nations - one which will lead to a series of violent
"Arab Springs" across the oil-producing developed world - but far
more importantly, have a massive impact on capital markets as a
result of the plunge in the most financialized commodity in
history.
On the death of the Petrodollar we commented that unlike
previously, when petrodollar recycling funneled the proceeds from
oil-exports into financial markets, helping to boost asset prices
and keep the cost of borrowing down, henceforth "oil producers will
effectively import capital amounting to $7.6 billion." We added
that "
oil exporters are now pulling liquidity out of financial
markets rather than putting money in.That could result in
higher borrowing costs for governments, companies, and ultimately,
consumers as money becomes scarcer."
The conclusion was simple: "net capital flows will be negative
for EM,
representing the first net inflow of capital (USD8bn) for
the first time in eighteen years.This compares with
USD60bn last year, which itself was down from USD248bn in 2012. At
its peak, recycled EM petro dollars amounted to USD511bn back in
2006. The declines seen since 2006 not only reflect the
changed global environment, but also the propensity of
underlying exporters to begin investing the money domestically
rather than save.
The implications for financial markets liquidity -
not to mention related
downward pressure on US Treasury yields– is
negative."
In retrospect, it probably was not "simple enough", because even
three months ago
everyonewas confident that both higher yields and
an increase in market liquidity are imminent. Since then not only
has the yield on the 10 Year plunged to near record low levels
(while 16% of global government debt now trades at negative
yields), but judging by the absolute liquidity devastation in
the E-Mini,
in Trasurysand virtually every other asset
class, few actually grasped the implications of what plunging oil
really means in a world in which this most financialized of
commodities plays a massive role in both the global economy and
capital markets, not to mention in geopolitics, with implications
far, far greater than the amateurish "
yes, but gas is now cheaper" retort.
So, three months later, we are happy to report that
somebody
finally noticed that the Petrodollar has indeed finally died,
and more importantly, has attempted to put together an analysis of
what we said in early November, reaching the conclusion that
plunging oil just may not be all that financial comedy TV has it
cracked up to be.
Did we say somebody? We meant everyone!
Below are extensive, in-depth, and
long overdue
questions on petrodollar recycling, or rather its halt, and
its implications from virtually every single Bank of America
economist and strategist who after months of stalling, have finally
been forced to confront this most critical of topics head on.
From Bank of America
Q&A on petrodollar recycling
We explore the economic, financial, and geopolitical
implications that will result from the collapse in oil prices and
the reduction in petro-dollar flows.
We see a limited impact on UST yields or the USD. In recent
years, the UK, Euro area and EEMEA have benefitted from reserve
diversification away from the USD. A drying-out of petrodollar
flows will reduce funding availability for current account deficit
countries, particularly the UK, and may hurt London’s real estate
sector.
Venezuela’s debtors such as Cuba, which benefitted from
Petrocaribe loans, as well as left-leaning regimes in LatAm, will
feel the pressure. Russia could lose regional influence, although
Ukraine’s dependence on its gas is still very high. Lower oil
prices should diminish the ability of Iran to project regional
power. Growth model limitations could eventually accentuate GCC
social pressures, in our view.
The oil market outlook
Alberto Ades, co-head of Global Economics:Sabine,
the natural starting point to a discussion of petrodollar recycling
is an assessment of the oil market. What is your reading of OPEC’s
policy shift?
Sabine Schels, commodity strategist:Before the
recent oil rebound, Brent crude oil prices came off almost in a
straight line from $115 to $50/bbl, making three very brief stops
at $85, $80 and $60.
That marks the second steepest six-month decline in the oil
market’s history.In a dramatic policy shift, OPEC supply
has kept increasing in recent quarters despite falling prices, as
Saudi Arabia seems intent on increasing its market share,
irrespective of the impact on price. Saudi Arabia has pledged not
to take out supply even if the price drops to $40, $30 or even $20
per barrel, suggesting curtailments will have to come from high
cost non-OPEC producers.
The sharp price decline is delivering a windfall-tax to
consumers globally while giving a major blow to producers. For GCC
alone, it is equivalent to $440bn in foregone revenues. In our
view, OPEC’s decision to give up on its traditional role of keeping
supply and demand in check
will have far-reaching consequences across all asset
classes as the flow of OPEC petrodollars is drying up.In
the absence of a quick and sharp rebound in oil prices,
this may drain liquidity from global asset markets, at
least for the remainder of 2015
.
Alberto Ades:Recently, you cut your oil price
forecasts significantly. What drives your bearish view on oil
prices for the next few months?
Sabine Schels:Basically, supply keeps running
above demand. The term structure of Brent, which preceded the
collapse in prices, continues to weaken across the next 12 months
as inventories are building at an alarming speed, setting the stage
for lower, not higher prices.
Inventories typically build because supply exceeds demand in any
given market. But in some markets, like oil or gas, storage
capacity is a finite number and price declines can accelerate as
inventories build. In previous oil price downturns, OPEC would
reduce supply as stocks built up to prevent a collapse in the term
structure of prices. After all, when the price of storage soars,
storage operators benefit and oil producers suffer
However, this new OPEC policy will likely create a large
inventory overhang, suggesting further downside risks to oil
prices. In fact, we see floating storage coming into play over the
coming months with
roughly 55 million barrels building on ships by the end of
2Q15 as land-based inventories across North America, Europe and
Asia fill up.But even floating storage is limited by its
very nature. If crude vessels fill up, shipping rates will spike;
and that is unlikely to help any oil producer in the world.
Alberto Ades:Given this new OPEC policy, couldn’t
non-OPEC producers simply turn off supply to stabilize prices? Are
these producers large enough to influence the market
significantly?
Sabine Schels:To restore equilibrium in the oil
market, we would need a sizeable supply cut of at least 1 million
b/d. In our view,
it is not reasonable to expect non-cartelized production to
shut down immediately as prices fall because many producers are
well hedged, face very low cash costs, are partially protected by
falling domestic currencies or tax breaks, or are notoriously slow
to react.According to our estimates, with the exception of
shale oil, which is cash flow intensive and thus dependent on price
(current or forward),
non-cartelized crude oil output in many parts of the world
is not price sensitive at all, particularly in the first 12
months.
In the absence of a moderating agent like Saudi Arabia, this
means prices have to fall below operating cash costs (non-shale)
or well below cash flow breakevens (shale) for marginal
producers.In our view, non-OPEC oil supply cuts will not
come easy in the short run, as operating cash costs sit below
$40/bbl. True, investments will be put on hold as some of the
world’s output is challenged below $70/bbl in the long run.
However, production guidance continues to point up in 2015 for most
listed companies. Unless production guidance for 2015 goes negative
or Saudi Arabia changes its policy, the market could become more
disorderly as oil prices find a floor around operating cash
costs.
As a result, we now expect oil prices to spiral down toward
the end of 1Q and target Brent at $31/bbl and WTI at
$32/bbl.
Alberto Ades:Since you expect no significant price
bounce in the near future, do you see a risk of the flow of
petrodollars drying up in the longer term?
Sabine Schels:We have argued that once spending
cuts by non-OPEC producers, most likely US shale oil, are in place,
Brent crude prices should start to recover. This will likely happen
in the second half of this year, to a year-end target of $57/bbl.
For 2016, we forecast Brent crude oil prices averaging $58/bbl. All
else equal, this should increase the flow of petrodollars to the
global economy, though to levels much lower than when oil was in
the $100+/bbl environment. However, there is a risk to our base
case. This assumption relies heavily on Saudi Arabian production
staying at around the current level of 9.7 million b/d. While the
kingdom pledges not to cut output to prevent prices from falling,
this new OPEC policy could imply raising output, thus
cutting into effective spare capacity. If this occurs, oil prices
may stay low for longer, depressing the flow of petrodollars for
years to come. This would allow them to increase their
market share as oil prices recover, rather than allow shale
producers in the US to reenter the market.
In this context, it is important to note that Saudi production
is close to a record high in terms of total output, but not in
terms of its share of the global market. So the question remains
whether the Saudis want to put their spare capacity to work in
coming years and increase output beyond 12 million b/d as oil
prices start to recover. In that scenario, we estimate the fiscal
budget breakeven price for the Kingdom would fall quickly, by
$22/bbl from $94/bbl currently, meaning much-trumpeted reserves
would last even longer to sustain this new policy.
Alberto Ades:Could a rebound in global economic
activity support an oil price recovery, even under the new OPEC
policy?
Sabine Schels:Our models suggest a six-month lag
before lower prices start to impact consumption positively.
Assuming the lower prices create no spiraling effect in emerging
markets, this means global consumption should accelerate
meaningfully in the second half of this year and into 2016.
Global oil demand is driven by net oil importing countries and
large oil producers. Incrementally, we still expect China and India
to deliver the bulk of the global consumption increase in 2015,
although we do not expect China’s oil demand to grow nearly as fast
as it did between 2004 and 2010, given domestic housing woes and an
expensive currency.
While large importing countries like the US, China and India
will likely see a bounce in consumption in 2015 and 2016, demand in
oil-producing countries could be meaningfully slower next year as
recession bites in Russia and lower oil prices negatively impact
Middle East economies. After all, many oil producers had
their cake and ate it too for years as oil prices rose.
As a result,
we remain very concerned that slower demand from
oil-producing countries could come back to haunt the
market.We estimate 50% of the growth in demand in the last
10 years has come from oil-producing countries,
a clear downside risk to prices, and the flow of
petrodollars,from here.
GCC: a possible tectonic shift in petrodollar
recycling
Alberto Ades:Jean-Michel, let’s turn to the
regional impact of the petrodollar recycling dry-up for the
countries in the Gulf Cooperation Council (GCC). How did these
countries recycle petrodollars during the oil boom years?
Jean-Michel Saliba, Middle East and North Africa economist: GCC
oil export earnings totaled roughly US$1.04tn in 2014, for a
cumulative US$10.8tn since 1970.
These revenues have been recycled through two main
channels, the absorption and financial account channels.
The former refers to the use of oil export receipts to finance
imports of goods and services. Through the second channel, current
account surpluses translate into
net financial investments in the rest of the world
. The split in these flows comes from the sovereign’s
intertemporal allocation decision between spending under the
absorption channel and saving under the financial account channel.
The latter also
involves an asset allocation decision.
Alberto Ades:Let’s first discuss the absorption
channel. How has it evolved since the 1970s?
Jean-Michel Saliba: GCC absorption capacity has
increased steadily with the launch of large diversification and
infrastructure spending programs. We estimate that around half of
the GCC oil export earnings were spent and recycled through imports
between 2003 and 2014. In comparison, during the oil boom of the
1970s and 1980s, the ratio of imports to exports increased rapidly
from 0.3 to 0.6 on average in the 1980s and then remained fairly
elevated on large domestic development plans and declining oil
prices. After peaking at 0.8 in 1986, the ratio has declined
gradually after the spending drop of the 1990s. This suggests the
absorption channel has diminished in importance for GCC this time
around.
Also, in the past, higher GCC imports lent support to global
demand and mitigated the widening of DM current account deficits
due to higher oil prices. In other words, imports were sourced back
from developed markets. Over time, this channel has become somewhat
USD-negative as trade links with the US decreased at the expense of
the rise in the share of Asia.
Alberto Ades:Is it safe then to conclude that the
financial account channel has recently gained importance for the
GCC?
Jean-Michel Saliba:Yes, and this is probably the
reason why this is the channel people tend to focus on when
speaking of petrodollar recycling. Current account data suggest the
GCC has accumulated $2.7tn in net foreign assets since the 1970s1,
$2.4tn of which has likely come during the most recent oil boom
that started in 2004
Saving GCC petrodollars in the form of foreign assets held
abroad has occurred largely through the official sector. In turn,
the GCC official sector’s outward investment has helped sterilize
oil receipts. This has shielded the domestic economies from
excessive or volatile liquidity, albeit only incompletely given the
presence of currency pegs and robust fiscal expansion.
Over time, the role of the GCC monetary authorities, except for
the Saudi Arabia Monetary Agency (SAMA), has been eclipsed by the
rise of sovereign wealth funds. This likely implies a less
risk-averse asset allocation by GCC.
Alberto Ades:You bring up an important new player,
namely the SWFs. Their relative size and influence over global
markets has increased sharply since the
1980s. What are the implications of this?
Jean-Michel Saliba:For one thing, the growing
relevance of the financial account channel and the rise of SWFs
have made it more difficult to track the flows accurately. Through
our work, we have been able to account for the geographical
destination of only about 50% of the accumulated GCC net foreign
investment.
Previously, tracking was simpler because the bulk of financial
flows passed through DM banks or DM securities markets. The GCC
current account surpluses could broadly be explained by increases
in FX reserves and bank deposits in the US and Bank of
International Settlements (BIS) reporting countries. For example,
between 1974 and 1979, 47% of total identified investments were
deposited in bank accounts in developed economies or used to
purchase UK or US money market instruments. The rest were simply
used for long-term lending, mainly to developing economies through
international banks. These patterns actually planted the seeds of
the 1980s debt crises when flows dried out.
This time, financial account flows appear to have gained in
sophistication, with diversification across a larger set of asset
classes and geographies, including regional and domestic ones. This
likely implies a potentially less risk averse asset allocation by
the GCC countries
Alberto Ades:Of what you have been able to track,
what are the geographical destinations of GCC petrodollar
investment flows?
Jean-Michel Saliba:We believe
the bulk of petrodollars recycled through the financial
channel ended, either directly or indirectly, in the deep and
liquid US financial markets.
After all, the rise in the GCC current account surpluses was
mirrored by the widening of the US current account deficit, whereas
Emerging Asia has run surpluses and the Eurozone has kept
relatively flat external balances. Therefore, these flows ended up
financing the US, for the most part. Petrodollars may have funded
an increase in domestic and regional investment on a relative basis
as well, but this remains hard to quantify. That said, the Abu
Dhabi Investment Authority (ADIA) allocation could be used as a
very rough guide on investment flows. Long-term neutral EM
benchmark exposure for ADIA consists of between 15% and 25% of
assets under management. This contrasts with 35-50% for North
America, 20-35% for Europe and 10-20% for Developed Asia. Note that
around 75% of ADIA’s assets are managed externally and some 55% of
ADIA’s assets are invested in index-replicating strategies.
In terms of the cumulative stock of identified GCC foreign asset
holdings, most of it is concentrated in foreign direct investments
in Europe, Asia, and the US, BIS offshore bank deposits and US
equities
Alberto Ades:What would be the main implications
of the dry-up in petrodollar recycling likely to happen in a lower
oil price environment?
Jean-Michel Saliba:Lower oil prices for longer
should imply material shifts in the size and direction of
petrodollar recycling flows
. Every $10/bbl drop in oil prices shaves off 4.2% of GDP
from GCC current account balances. The move in oil prices between
US$115/bbl and US$52/bbl would therefore shave off US$440bn in
export revenues annually.
The GCC external current account breakeven oil price is at
approximately $65/bbl,which would only make the region a
net external creditor if oil prices rebound sharply this year. The
regional fiscal breakeven oil price is at $85/bbl, suggesting the
GCC is set to run a fiscal deficit on aggregate, the bulk of which
is likely to be financed through a drawdown of foreign assets
currently held abroad.
History suggests GCC’s fiscal adjustment occurs with a lag. This
would imply a sticky absorption channel through still elevated
imports in the near term. During the first year or so of low oil
prices, a country such as Saudi Arabia would draw down its official
reserves to finance the balance of payments gap. These assets are
most likely invested in foreign deposits and liquid US securities,
which would take a hit. Later, financial account flows, which in
the era of high oil prices were invested abroad to sterilize oil
receipts, would likely reverse their direction. This would leave a
more manageable drawdown of official central bank assets.
Petrodollar shifts could reshape the geopolitical landscape
Alberto Ades:Jean-Michel, let’s conclude by
discussing the changing geopolitics. What impact do you expect for
the Middle Eastern conflicts?
Jean-Michel Saliba:Over a longer time frame, we
would expect lower financial support to regional proxy armed groups
to weaken some of the geopolitical dynamics on the ground. However,
this can be moderated by various factors. First, in the local
press, the Iranian leadership has expressed its belief that the new
Saudi oil policy regime has clear geopolitical motives. The closest
analogy is perhaps the 1985 Saudi oil policy regime shift, which
sent oil prices tumbling and weighed on the conduct of the
Iran-Iraq war. Iranian Foreign Minister Zarif recently suggested
that lower oil prices diminish the possible gains of the Iranian
regime concluding a nuclear deal with the P5+1 countries. Also, we
note the Iranian macro adjustment could make the threat of further
sanctions less potent.
Second, the resurgent Houthi military gains in Yemen, continued
engagement in the Syrian conflict and recent Hezbollah-Israeli
hostilities suggest Iranian regional ideological involvement is
unlikely to alter course materially in the near term given the
elevated stakes. In addition, a number of regional proxy armed
groups were founded in the mid-1980s and appear to have developed
alternative financing mechanisms.
Finally, in some instances, lower oil prices could accentuate
sectarian conflicts in the Middle East. We suggested a risk to the
colonial Sykes-Picot borders in Iraq, which has been addressed
imperfectly through US external intervention and the recent
budgetary agreement between Baghdad and the Kurdistan Regional
Government. However, low oil prices challenge the economics of the
deal and deepen Iraq’s fiscal strains and liquidity crunch.
Alberto Ades:Venezuela is another oil exporter
that will also be directly impacted. Francisco, how did Venezuela
recycle petrodollars during the previous oil boom? I get the sense
that geopolitical trends in the region can’t be understood without
a reference to Venezuela and the “grants” it distributed to
countries with shared political affinities. Is this correct?
Francisco Rodríguez, Andean economist:Definitely.
High oil prices in recent years allowed Venezuela to expand its
influence in the region. The cost of this was very large for the
country. We estimate the stock of loans to regional allies
currently outstanding totals $25bn. This is larger than the current
Venezuelan international reserves. In other words, the opportunity
cost of Venezuelan foreign policy was not building a stabilization
fund that would have enabled it to smooth out the adjustment during
periods of declining oil prices.
These policies are unsustainable at current oil
prices.In fact, the data already show a notable decline in
trade credits and other public sector investment assets, two
capital account items that essentially capture the change of
liabilities of other countries with Venezuela generated as a result
of Petrocaribe and other cooperation agreements. Net lending to
other countries, as captured by the sum of these lines, fell to
$1.9bn in the first three quarters of 2014 from $5.9bn and $11.2bn
for comparable periods in 2013 and 2012, respectively.
Alberto Ades:And are we already seeing some of the
effects of these drying out?
Francisco Rodríguez
:Absolutely, the restoration of full diplomatic relations
between the United States and Cuba is an important byproduct of
this decline in Venezuela’s influence. From Cuba’s vantage point,
the need to change its sources of external income is evident. As of
2013, it received oil shipments from Venezuela totaling 98mbd. In
our view, the implications of this important announcement reach
beyond Cuba’s borders, as it can help reshape the relationships
between the US and Latin America, a region where a large fraction
of governments is headed by leftist parties.
Alberto Ades:We cannot discuss geopolitics of oil
without discussing Russia. Every day we hear that Russia will not
only be affected economically but also politically, and even
socially. Vladimir, overall, how important is oil for Russia?
Vladimir Osakovskiy, Russia and CIS economist: We
believe the impact of oil prices goes well beyond the economy and
deeper into Russian society. This dependence goes all the way back
to the late 1970s, when the then USSR became one of the major
energy exporters and an important player on the global energy
markets. In periods of relatively high oil prices, the abundant
inflow of capital tended to create strong momentum in the economy,
which also coincided with periods of a very assertive foreign and
domestic policy
For example, historically high oil prices between the late 1970s
and early 1980s correlated with the peak of the tensions between
the US and the USSR in various parts of the world. More recently,
record high oil prices in mid-2008 and between 2011 and early 2014
coincided with a brief war with Georgia in August 2008 and the
political crisis in Ukraine. On the contrary, periods of low and
falling oil prices have coincided with times when Russia’s
relations with the West tended to improve. We can say that with
respect to the entire Perestroika in 1987 and the US-Russia reset
in early 2009.
Also, there are numerous ways in which such high oil revenues
have been converted into political capital. Obviously, more
abundant capital gave the government a greater ability to increase
spending on such a political item as defense, which gave it more
tools for an independent foreign policy on the international
agenda. Russia's defense spending reached peaks in the mid-1980s
and in 2014.
Similar to what Francisco described for Venezuela, abundant and
expansive energy resources also provide a lot of “soft power” that
can be converted easily into political benefits through discounted
gas shipments, direct financial support to loyal governments, etc.
Over the past 5-10 years Russia has been quite active in supporting
loyal governments in Belarus, Armenia and Ukraine. However, the
capacity for such soft power is declining with lower oil prices
and, even more importantly, the value of energy concessions that
Russia can offer is falling as well.
Alberto Ades:Vadim, with all this background that
Vladimir outlined, can we expect easing of the geopolitical
tensions in Ukraine as a result?
Vadim Khramov, Ukraine and CEE economist:From the
geopolitical standpoint, there is an argument that Russia would
have to take a softer stance on Ukraine, as falling oil prices and
western sanctions hurt the Russian economy. For now, the conflict
in eastern Ukraine is still ongoing and at the end of 2014, there
was even some escalation of tensions. Therefore, it is hard to say
that Russia is taking a softer stance on Ukraine for now. However,
we do not know the counterfactual on the situation had oil prices
stayed high.
One major issue is related to Ukraine energy imports from
Russia. As you know, Ukraine is an energy importer. According to
our estimates, the recent drop in oil prices will allow it to save
about $4bn on the imported gas bill as well as $3-4bn on
petroleum-related imports. Also, Ukraine’s energy dependence on
Russia has reduced not only in price but also in volume terms. This
limits Russia’s ability to add more pressures on Ukraine.
That being said, our estimates show that Ukraine still will have
to buy almost half of its gas imports from Russia in the next few
years, as large gas substitution from Europe is unlikely.
Therefore, even under a situation with low energy prices, Russia
can add pressure on Ukraine along the energy lines. For this
reason, in my view, the short-term impact of low energy prices on
the Ukraine conflict overall is still limited.
Alberto Ades:Let’s briefly discuss potential
impacts on domestic policies in Russia. Vladimir, are these
affected as much as foreign policies?
Vladimir Osakovskiy:Sure. In the past, discussions
about reforms in Russia have occurred during periods of low oil
prices. For example, the USSR started democratization and its move
away from the planned economy in the late 1980s when it was facing
massive resource constraints due to a sharp decline in oil prices.
After oil prices dipped below $10/bbl, Russia was pushed to accept
the IMF program in 1998, even though it did not help to avert the
default.
Conversely, the intensity of Russia's reforms fell quickly and
the government increased its assertive control over society as oil
prices started to rise at the beginning of the century. The
reformist and democratic agenda had a tentative recovery in 2009
when the oil price dropped below $30/bbl. However, this period
faded quickly, just as oil prices recovered quickly.
* * *
Strategy impact will be larger for FX than for
rates
Alberto Ades:Gustavo, let’s switch away from
regional geopolitics and back into global economics and strategy.
As petrodollar recycling dries out, will this hit global liquidity
conditions?
Gustavo Reis, global economist:Jean-Michel noted
petrodollar flows likely ended up in liquid US financial markets;
therefore,
a consequent effect would be diminished support for US
asset prices.
There are other adjustments that can override this, however.
Unlike in the 1970s, when oil revenues were mostly recycled through
banking channels, the ongoing adjustment in global rates and
exchange rates is key to understanding how petrodollar flows will
ultimately affect overall financial conditions.
Our Global Liquidity Tracker shows the recent oil price drop
coincides with a moderate tightening in global liquidity
conditions. The higher market volatility and diminished risk
appetite have offset the drop in global bond yields. Much of this
reflects global growth concerns, which have also been weighing on
oil prices. Moreover, monetary policy in the Euro area and Japan
will probably deviate from the playbook of looking through oil
price changes by responding assertively to increased deflation
risks.
Despite the uncertainty on recycling routes, my view is that
petrodollar flows will be of second-order importance to global
liquidity in 2015. Estimating the impact of petrodollar flows on
global market conditions a decade ago, the International Monetary
Fund found them to be limited.
A more patient Federal Reserve, additional easing by the
European Central Bank and Bank of Japan, as well as the decline in
long-term global inflation expectations, will likely dominate. This
suggests a contained potential impact of petrodollar flows over and
above the market gyrations associated with the oil price
plunge.
Alberto Ades:Shyam, in terms of strategy, given
the GCC’s sizable holdings of US fixed income assets, what will be
the impact on US rates? Should we expect a sell-off of US
Treasuries?
Shyam Rajan, rates strategist:As Jean-Michel
mentioned, there is definitely a risk that countries like Saudi
Arabia will draw down liquid US securities to finance any balance
of payments gap. After all, according to the latest TIC holdings
data, OPEC nations hold about $280bn of UST, with another $200bn
held by Russia and Norway.
However, we are less concerned about the impact of this flow on
the rates market for two reasons. First, corporate bond and stock
holdings of Middle East oil-exporting
nations have increased by almost twice that of UST over the
last four years (up about $70bn since 2010). This increased
preference for higher-yielding and higher-risk assets likely
explains why the relationship between UST flows from this region
and oil prices has weakened substantially recently. This is
consistent with Jean-Michel’s intuition that the emergence of SWFs
has probably led to a less risk averse allocation by GCC.
Second, sales by these countries are usually more than offset by
other flows. It is important to remember that the top four oil
importers excluding the US (China, Japan, India and South Korea)
own five times the amount of UST held by the oil exporters.
Increased buying from these countries could therefore easily offset
any sales.
In addition, a further drop in oil prices as envisioned by
Sabine would probably increase risk aversion and safe haven flows
into the UST market.
Alberto Ades:Talk of UST yields and inflation may
have implications for Fed action. Mike, could the shift in
petrodollar recycling influence the Fed’s monetary policy during
2015?
Michael Hanson, United States economist:Not in my
view. For the Fed, the decision on when to begin the tightening
cycle will depend on how it assesses the progress toward maximum
employment and price stability in the dual mandate. But as the
January FOMC statement revealed, financial and international
developments will also play a role.
If the shedding of US assets by oil-exporting economies
results in an appreciable tightening of US financial conditions,
the Fed may move later or more gradually in its exit
strategy
.
* * *
In other words, from irrelevant, to "unambiguously good" if only
for those who have zero understanding of what it means, suddenly
the end of the Petrodollar recycling chain is said to impact
everything from Russian geopolitics, to global capital market
liquidity, to safe-haven demand for Treasurys, to social tensions
in developing nations,
to the Fed's exit strategy.
Or said otherwise, we now know why the Fed felt like adding the
word "
international developments" in its latest
statement.