Powell’s ‘foggy night’ will affect weather in the GCC

Jerome Powell talked of driving at a slower speed in the face of unknown challenges ahead

December 20, 2024, 3:20 PM

Donald Trump and Jerome Powell at his nomination in 2017; inflation risk now 'haunts Trumponomics to an extent that was simply not the case in the president-elect's first term' — Donald Trump and Jerome Powell at Powell's nomination in 2017; inflation risk now 'haunts Trumponomics to an extent that was simply not the case in the president-elect's first term'

Wall Street folklore contends that four key prices constitute the heartbeat of global finance. These are the price of money (US Treasury bond yields), the price of currency (US Dollar Index), the price of oil, and the price of gold.

The Federal Reserve predictably cut its policy rate by 25 basis points to 4.25 percent on Wednesday at its December Federal Open Market Committee (FOMC) but triggered a sell-off in global risk assets after it voted to slash projections of rate cuts in 2025 from from four to two.

Chairman Jerome Powell delivered another shock to financial markets in his post-FOMC speech when he said that the US central bank has dialled down its expectations of monetary easing in 2025 because “policy uncertainty” has raised inflation risk.

This was an elliptical reference to Trump’s economic policy agenda, notably punitive tariffs, the deportation of millions of illegal migrants and major tax cuts.

Powell used the metaphor of driving at a slower speed during a “foggy night” and raised the FOMC’s projected end-2025 inflation rate to 2.5 percent from the previous 2.1 percent.

The Volatility Index (VIX), Wall Street’s pendulum of greed and fear, surged to its highest level since the pandemic even as the S&P 500 slumped by 3 percent – its worst one-day fall since March 2020.

Fear replaced greed as a dominant theme in global markets the moment the Powell Fed flagged inflation risk in 2025.

The Fed’s move has raised the price of money as US Treasury bond yields spiked higher across the yield curve. The 10-year US Treasury note rose from 4.38 percent to 4.53 percent, an ominous signal for global economic growth since the bellwether note’s yield has now risen almost 100 basis points in the past two months.

Inflation risk now haunts Trumponomics to an extent that was simply not the case in the president-elect’s first term.

The price of oil will come under pressure from the rise in Treasury bond yields

The prospect of public acrimony between President Trump and the central bank chief has once again unnerved the US Treasury bond market. The yield on the 10-year note is headed higher to a new trading range, from the current 4.53 percent to as high as 5 percent in 2025.

The price of currency, as defined by the US Dollar Index (DXY), has hit two-year highs and was rising even before Trump’s election win. The DXY is now at 108 and the euro, its biggest constituent at a 57 percent weighting, has slumped to 1.04 versus the dollar.

There is nothing sacred about parity. The euro fell as low as 0.82 after the introduction of the single currency in 1999.

The debt and budget crisis in France, Germany’s industrial recession, the threat of US tariffs, the protracted bloodbath in Ukraine, and a plunge in EU exports to China mean that bearish psychology on the euro now dominates Planet Forex.

The price of oil will come under pressure from the rise in Treasury bond yields. King Dollar strength, anaemic Chinese demand and a surge in US shale output above its current 13.5m barrels per day, as well as new oil supplies from Guyana, Brazil, Canada and offshore West Africa will also contribute to price weakness.

The prospect of Trump’s “maximum pressure” sanctions on Iran and Saudi brokered Opec+ supply curbs should keep Brent in a $65-$80 trading range in 2025.

The price of gold fell by $40 an ounce after the FOMC meeting. However, the gold rally has been immune to previous spasms of greenback strength and rising Treasury bond yields. Its primary ballast is Chinese central bank buying after the US froze Bank Rossiya’s assets in the aftermath of Putin’s invasion of Ukraine.

Gold is also a hedge against higher inflation risk and the fiscal black holes in the US, Europe, Japan and China. The depreciation of the yuan has also attracted Chinese flight capital to the yellow metal, which is also a safe haven for investors in hyperinflationary economies such as Egypt, Turkey and Pakistan. Gold’s expected trading range in 2025 is $2,500-$2,900 an ounce.

The four heartbeats of global finance will echo in the GCC’s capital markets.

Higher US Treasury bond yields and a pause in Fed rate cuts mean that GCC central banks will not be able to inject liquidity into regional economies.

The difference between current spot Brent price is at least $30 below Saudi Arabia’s budget breakeven price. It is thus rational to expect Saudi sovereign debt issuance will lead the emerging market dollar bond league tables, even though its net cost will rise in 2025 as US Treasury bond yields stay higher for longer.

Rising bond yields will also pressure the 20-times-earnings valuation of the Tadawul, Saudi Arabia’s primary equity index.

Dubai should continue to outperform GCC equities as its valuation is modest at 10-times-earnings and the sources of its earnings growth is primarily the emirate’s real estate bull market and net population rise.

Oman and Bahrain will also face a rise in net borrowing costs as Trump’s economic policies cause sovereign credit risk spreads to widen for lower rated borrowers. The GCC’s average valuation of 14.8-times-earnings will also be pressured by higher Treasury bond yields.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah