By: Dr. Salwa Hammami Labib and Nick Groene
The peg between the currencies of the GCC and the US, essentially gives us a one-size-fits all monetary policy. By following the Fed, short-term interest rates in the UAE have broadly chased the federal funds rate. If and when the US tightens, all indications are that the GCC will follow suit. Notwithstanding the differentiated macro-economies and incongruous inflation expectations, it seems the GCC may well wait on the US before it unilaterally makes any move this time around.
However important is the US to the region’s markets, we would like to draw attention to the bigger picture. The story today lies in Chinese tightening. Tuesday 12th story of People’s Bank of China (PBoC) raising the reserve requirement ratio for banks by 0.5% probably marks the onset of a long and winding phase of monetary contraction, especially given China’s resistance to appreciate the yuan.
Consider this: for all we know, China may choose to continue tightening, pre-empting an overheating economy, while quantitative easing is still in train in the US. Current rates of US resource utilization, US inflation trends, and US inflation expectations continue to warrant a loose monetary policy for a period conceivably extending beyond mid 2010. This may well leave us a with 3-6 month window period during which PBoC tightens but not the Fed.
Lately, the foremost additive to global liquidity has come from China. Once that arrests, it could potentially trigger a re-pricing of assets globally. Chinese monetary tightening, or the expectations of it, may set the agenda for a broad correction in risky assets, with ripples spreading from the Pacific Rim to all emerging and then globally.
As risks for equities and commodities could lie on the downside, Chinese monetary tightening could create a challenging situation for the region. Gulf equity markets have diverted from Asian markets during the recovery phase as home-grown risk factors surfaced of late. In the absence of a strong home-grown catalyst, the regional markets still ache for the backbone they need to continue normalizing. The question today is whether the next leg down or any renewed bearishness in risky assets will be shadowed by the GCC equity markets, putting off their rally for a while.
