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Business: Assif Online - Volatile Markets
Made more so by the swings in oil prices

September 12, 2000
Web posted at 6.00 p.m. Hong Kong time, 6.00 p.m. EDT

Until recently, the main concern in global markets has been inflation. To nip this bad apple in the bud, the U.S. Federal Reserve has in pre-emptive moves been hiking interest rates since last year. That cycle ended about three months ago. The equity markets are now reflecting the fact that U.S. Fed Chief Alan Greenspan is done with raising rates -- for a while yet. The global bond markets, when you cut out all the gobbledygook, are basically telling us that not only is the Fed done with raising rates, there actually could be a rate cut sometimes between March and June next year. Thus the strong performance of financial sector stocks on Wall Street in recent weeks.

But while equity and bond markets are reflecting all the good news, at least one part of the commodity market, oil, is pointing the other way. But more on that later. The Forex markets -- which normally move in tandem with interest rates and economic fundamentals -- are fairly volatile right now. The European Central Bank (ECB) raised rates two weeks ago only to see the euro weaken further. Meanwhile, the Bank of Japan ditched its zero interest rate policy last month, saying there will be no more rate hikes for the foreseeable future. The yen has strengthened. The dollar remains almighty.

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With high productivity growth in the U.S. and no signs, yet, of inflation, money from all around the world is just pouring into American assets -- equities, bonds, property, private companies or anything else they can get hold of. The result is that U.S. dollar continues to strengthen as demand for dollars just grows and grows. In the past few weeks, Deutsche Telekom has bought U.S. cellular operator Voicestream, Credit Suisse has bought U.S. investment bank Paine Webber and its its main rival in Switzerland, UBS, has bought investment bank Donaldson Lufkin Jeanrette (DLJ). Just these three deals total nearly $100 billion. The buzz is that Deutsche Bank, which paid $20 billion for Bankers Trust two years ago, is now ready to pounce on another investment bank, J.P. Morgan, which could be worth $30 billion to $35 billion. Scores of German, French and British companies are making or scouting for deals worth tens of billions of dollars. Most of the deals are one way -- acquisitions in the U.S. Very few U.S. companies are actually engaged in overseas shopping sprees, even though the strong dollar makes the rest of the world looks like a bargain for Americans. A few more big cross-border deals and stronger U.S. equity markets would mean much a weaker euro, even if the ECB continues to raise rates.

The limp euro and strengthening oil prices are putting pressure on some of the smaller Asian currencies, like the Philippine peso and Thai baht (both of which have seen two-year lows in recent weeks). The Singapore dollar and Australian dollar, which more or less correlate with the euro, have been weaker too. The rupiah has held up well only because of the spike in oil prices.

So, what about oil ? The reason equity and bond markets are fairly unconcerned about the skyrocketing oil prices is because almost everyone seems to believe that the oil price rise is temporary. Moreover, even if the prices are sustained at $30-$35 levels for a while, U.S. productivity growth and economic slowdown would more than counter the impact of higher oil prices. Oil prices are leading not lagging indicators of demand and the lead is about three to four months. September and October are normally the peak. As the Northern Hemisphere goes into winter, oil prices actually start to taper off because oil prices start to reflect the spring demand. A milder winter this year would drastically depress oil prices. A severe winter -- given current shortages -- will add fire to the fuel prices.

Capacity constraints mean OPEC just can't open up the taps much further. Some analysts believe that, excluding Iraq, OPEC has no more than 1 million barrels a day of spare capacity. (Last weekend's agreement raised the daily quote by 800,000 to 26.3 million barrels a day.) High prices and slightly severe early winter would combine to play havoc with the oil market and might bring Greenspan back to his rate-rising work.

Oil is a sword that cuts both ways. Among the big winners in Asia are the likes of Indonesia and Malaysia. Indonesia, which pumped 1.1 million barrels in at the depth of its recession and political turmoil in 1998, got an average of just over $13 per barrel from its oil in 1998 or $5.3 billion. Now Indonesia is pumping 1.37 million barrels a day. This year with an average daily production of 1.35 million barrels and average price of about $30, Indonesia could earn over $14.8 billion from oil alone -- or two and half times what was provided for in the budget. (Indonesia also exports gas and chemicals, which are also fetching higher prices so the overall bonanza for Indonesia is actually much bigger, though it still imports cheaper oil for its own domestic use.) Malaysia's 700,000 barrels a day for mostly light and sweet crude (which sells at a slight premium) might average $30 per barrel this year or $7.6 billion in total.

Among the losers are Japan, Korea and Taiwan, which are all large net importers of oil as well as gas. But with huge additional income from exports of electronics goods as part of the global Information Technology boom, they can easily afford to pay more for oil. Bigger losers are the likes of the Philippines and Thailand, which are stuck with a few additional billion dollars on their import bill, higher inflation and bigger budget deficits because the governments haven't been able to pass on higher prices to citizens fast enough. That is depressing the currencies, derailing already fragile economic recoveries and pushing down the stock markets as foreign investors either stay on the sidelines or sell out. And where might those proceeds be going? Three guesses, as the Americans say.

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