Dollar, crude could knock global economy out in 2015

Moneycontrol Bureau

The recent strength in the US dollar and the dramatic fall in crude oil prices have brought in focus the potential impact they could have on the global economy.

Over 2014, the US dollar index, which tracks the greenback’s strength against a basket of six currencies, has gained over 10 percent. While crude, now at USD 59 a barrel, has now fallen almost 50 percent from a peak of USD 115 in June this year.

And underlying both is a common feature: the strength of the US economy led by the shale revolution.

Barring an unexpected 2.1 percent contraction in the first quarter of 2014 following a severe winter, the quarterly GDP growth data for the world’s largest economy reads like this: 4.5 percent (2013Q3), 3.5 percent (2013 Q4), 4.6 percent (2014Q2) and 3.9 percent (2014Q3).

While years of loose monetary policy aimed at spurring consumption has played a part, the US strength has also partially been driven by an explosion in shale exploration – driven by a technique called ‘hydrofracking’ that has existed for decades but has only now become widespread. The shale revolution has not only made US the largest producer of natural gas but could also see it becoming the biggest oil producer next year.

Amid this, the 12-nation oil cartel OPEC, dominated by countries from the Middle East, have abstained from cutting output in the face of falling prices. It is believed OPEC wants to drive the fledgling US shale industry out of business, many of whom have exploration costs higher than USD 60 per barrel, higher than the USD 30-40 enjoyed by traditional explorers.

The movements in both asset classes can throw a spanner in the works for the global economy.

It is known that a strong US dollar is a negative for risk assets such as stocks. In fact, the US dollar index is trading close to the level it had reached during the global financial crisis when panicked investors, while fleeing high risk emerging markets, sought the refuge of the perceived safe haven.

The dollar strength coupled with proactive devaluation by countries such as Japan (which unveiled a massive USD 700 billion quantitative easing program) could further exacerbate currency volatility going into 2015.

But it is the nuanced role of crude oil, where generally weakness is perceived as a positive for the global economy, which could be trickier to assess.

The collapse in oil prices could play havoc with the budgets of several oil-exporting economies such as Russia (whose currency has fallen 50 percent year-to-date), Iran and Venezuela, among others.

But according to many analysts, the weakness is also indicative of the acute weakness in major global economies (barring US) such as China, Japan and the Eurozone.

Growth in China has fallen to a five-year low while Japan and several economies in the Eurozone continue to flirt with recessionary trends.

Amid such an economic environment globally, it is difficult to imagine how risk assets such as stocks can thrive.