Here come the petrodollars, back to save global asset prices
It’s the potential reversal of part of the global "quantitative tightening" that was said to have occurred as oil prices dropped precipitously, and could amount to an extra shot of liquidity at a time when central banks are beginning to normalize monetary policy.
"The increase in oil prices is generating a shift in flows and incomes across the world, effectively reversing the previous big shift seen between 2014 and 2016," wrote JPMorgan Chase & Co. analysts led by Nikolaos Panigirtzoglou. They estimate that energy producers stretching from the Middle East to Norway saw their oil-related revenues plunge from $1.6 trillion in 2014 -- when crude reached $115/bbl -- to less than $800 billion in 2016, when it fell to $27.
The drop in oil-related proceeds roiled global markets by cutting off producers’ demand for imported goods and curtailing the ability of big sovereign wealth funds and central banks to buy foreign assets. Those funds and FX reserve managers may have purchased $160 billion less in public stocks and $80 billion less of bonds as a result of the slump in crude during the two year-period, JPMorgan said in research published on April 20.
It’s a sentiment echoed by Goldman Sachs Group Inc., where Head of Commodities Research Jeffrey Currie this week argued that higher oil prices won’t necessarily crimp consumer demand even as the price of the global benchmark Brent reaches $75.23/bbl -- the most since late 2014.
"You’d have to get to really high prices here before it begins to damage,” Currie said in a Bloomberg TV interview. "What we see going over the last 15 years is that higher oil prices lead to creation of global excess savings. Petrodollars then get lent out and stimulate demand growth."
Barclays Plc analysts previously estimated that reinvestment of petrodollars amounted to a liquidity injection on a similar scale to the Federal Reserve’s own quantitative easing. As petrodollar flows reversed, they argued back in 2015, the world lost $400 billion in annual demand for financial assets.
The degree to which new oil-related liquidity gets reinvested and in what ways remains up for debate, however. Middle East producers have seen their FX reserves dwindle as they fund budget deficits in the face of lower oil prices and may opt to save rather than spend. And net foreign assets in Saudi Arabia -- the world’s biggest exporter -- have yet to show a significant increase despite the higher cost of crude.
The breakout in oil could further loosen financial conditions by pressuring the U.S. dollar. If benchmark crude rises “further through” $70 to $80/bbl, sovereign wealth funds could diversify their foreign-exchange holdings -- potentially creating a headwind for the beleaguered greenback, according to Mansoor Mohi-uddin, head of currency strategy at NatWest Markets in Singapore.
Over the past decade, changes in the Brent price were often positively correlated with the euro -- particularly when the commodity exceeded the fiscal and current-account benchmarks of exporting nations. The relationship has largely vanished over the past 12 months but could return once again if oil prices continue to march higher.
In this scenario, "all the Middle East’s largest energy producers are likely to build excess FX reserves increasing the risk of renewed dollar diversification out of the region," Mohi-uddin wrote in an April 21 note. If that happens, the strategist reckons the dollar will struggle to appreciate within its current 1.20-1.25 range against the euro.
To be sure, America’s shale revolution, the propensity of energy producers to lavish more of their savings at home, and the end of oil prices at their dizzying highs mean the petrodollar supercycle is less powerful relative to yesteryear. But the prospect of Saudi Arabia’s foreign assets rising this year underscores the tentative return of these sovereign drivers of international capital flows.
The tailwind from oil prices will be more pronounced on stock prices -- as oil companies buy back shares -- while constituting a headwind for fixed-income, according to JPMorgan, even as a glut of global savings has traditionally boosted U.S. bonds.
Lower oil prices effectively shifted money from producers to consumers, and companies with fattened profit margins deposited extra cash into the banking system -- most of which found its way into bonds, the analysts argue.
"The rise in oil prices should create a positive flow in equity markets this year," they said. "Where the rise in oil prices poses more risk is in bond markets as the squeeze in oil consumers is reversing their previous saving impulse of 2015/2016, creating a bearish flow for bond markets this year."