Rising energy costs significantly impacting households

Last week was heavily influenced by the ongoing geopolitical crisis in the Middle East.

Concerned about potential escalations from the conflict and their repercussions, I focused on the Hormuz in my post from the previous week due to rising oil prices that could destabilize emerging and borrowing market economies.

If this situation persists, sustaining current prices will become increasingly difficult.

This is why I mentioned last week that the Federal Reserve is unlikely to reduce interest rates until there are clear signs of inflation slowing down.

We are currently facing a troubling combination of heightened inflation and tighter liquidity conditions. Policymakers are tasked with ensuring price stability, but in situations where there are fears of supply disruptions and uncertainty, traditional monetary policy becomes ineffective.

Rising energy costs are significantly impacting households and the economy, driving up business expenses and contributing to higher inflation. In such circumstances, raising interest rates becomes a precarious decision for the Central Bank, as it could further diminish demand and increase unemployment.

In these scenarios, a more prudent approach would be to accept higher inflation while ensuring sufficient liquidity is available to stave off financial strain.

On Friday, the US non-farm payroll data surprised the market by showing a contraction of 92,000 jobs, contrasting sharply with the anticipated increase of 65,000, and the unemployment rate ticked up to 4.4% from 4.3%. While the US payroll report is typically a key economic indicator that guides analysts and traders on future economic trends, its significance was diminished this time due to the war in the Middle East.

Although the US stock market may have experienced nearly a $ 3 trillion loss last week, the more pressing concern is that persistent inflation, an economic slowdown, and job losses might lead to stagnation.

OIL

Countries that do not produce oil are facing a challenging period due to the uncertainty surrounding future oil prices, which hinge on the outcomes of the ongoing war.

The reduction of traffic in the Strait of Hormuz through which nearly 20% of the world’s oil supply is transported poses a significant threat.

In addition to oil, the Strait also serves as a channel for about 80% of Liquefied Natural Gas (LNG) headed for Asia, as well as significant amounts of fertilizers, oilseeds, grains, food, agricultural products, industrial materials, general cargo and other essential products for regional trade flow through this key passage.

Moreover, Qatar has announced shutting down of gas Liquefaction, the reduction of oil production, prompted by oversupply, presents an additional risk.

If oil production ceases for a brief period, say less than a month and the infrastructure remains undamaged, production can resume relatively quickly.

Conversely, if oil production is halted for an extended duration, initiating production once again could take a considerable amount of time.

Until stability is restored, all eyes will remain on the Hormuz to see when normal operations can resume.

The ongoing situation contributes to a persistent risk premium. Even if the conflict ends soon, oil prices are likely to remain elevated.

Predicting future prices is challenging, but it is clear that oil pricing will depend on supply stability, the condition of shipping lanes, and insurance costs.

Given the upward trend in prices for gold, silver, copper, and other commodities, if oil prices keep rising, we could see similar increases, potentially reaching between USD 150 and USD 200 per barrel.

Many airlines took steps to hedge against rising oil costs last week, indicating that oil prices will likely remain high for a while.

Even if a resolution is reached quickly, oil prices are not expected to drop back to USD 60 within the next few months.

GOLD

Following an initial surge in gold purchases on Monday, prices dipped by over USD 350 before recovering in response to disappointing US jobs data.

This illustrates how markets can respond to geopolitical events related to oil.

A similar pattern was observed after the onset of the Russia-Ukraine conflict, as well as following major events in Venezuela and the Gulf region. Markets tend to respond proactively, spiking leading up to and during significant occurrences, but then typically stabilize and correct thereafter. This trend has been evident in gold’s behaviour.

In this instance, we may see a similar pattern, as all indicators suggest rising oil prices. Traders are likely to adjust their positions accordingly. I am uncertain of the Central Bank’s strategy regarding gold purchases for their reserves, but in these uncertain times, the priority should be ensuring ample liquidity in USD for transactions and managing associated external risks.

This situation is particularly sensitive for emerging economies, which face the threat of capital flight from foreign investments into safer assets.

Much will depend on the resolution of the Gulf conflict and the timeline for its settlement.

On Friday, gold prices surged following the release of unexpectedly weak non-farm payroll data. Although gold that rose in late New York trading is anticipated to initially climb in Asia, it may eventually ease. If oil prices exceed USD 100 per barrel, that could negatively and briefly impact gold.

However, if the war extends over a longer timeframe, both gold and the USD are expected to appreciate.

While I am not asserting that gold will decline, it could see corrections, yet there will likely be buying interest at lower price points.

For a return to bullish momentum, gold will need to surpass the USD 5420-50 barrier.

SBP monetary policy

The State Bank of Pakistan (SBP) is set to announce its monetary policy. I don’t anticipate any changes to the SBP’s policy rates.

The recent substantial increase in fuel prices is a wise, sensible, and timely decision.

Like other emerging market economies, our country is currently facing numerous risks due to geopolitical factors.

The economy struggles to cope with elevated oil prices, especially when combined with trading risks that could negatively affect both our exports and imports.

An easing of tensions in the Middle East would be beneficial for our economy. If unrest continues, it may adversely impact growth, increase pressure on the current account, and affect the balance of payments, which could signal instability for the Rupee.

Sustained high oil prices would likely drive inflation even higher, potentially resulting in an increase in the SBP policy rate.

Although it’s too early to draw any final conclusions, I would rather adopt a wait-and-see mindset concerning future developments instead of rushing into tough decisions. Any increase at this point would raise the likelihood of additional rate hikes in the next meeting.

I say this because I want to observe the job market in the Middle East and the trend of remittance inflows.

The SBP has worked diligently to boost remittances to record levels, and it must remain vigilant and strategic in this area.

Consequently, I don’t expect any early surprises from the SBP in the market.

WEEKLY OUTLOOK — MAR 9-13

GOLD @ USD 5171— We are approaching another week of volatility. For market participants the key levels to watch are USD 5260 and USD 5378. On the downside, if the price breaks below USD 5070, there is a risk of testing and potentially breaking through the USD 5000 level. Buyers are anticipated to enter the market if gold prices decline.

EURO @ 1.1618— The Euro is anticipated to maintain support at 1.1520 during declines. It must rise above 1.1765 to reach 1.1815. A breach of the support level could lead to a drop to 1.1475.

GBP @ 1.3413— The Pound Sterling has support at 1.3260 and is expected to attract buyers on pullbacks. However, unless it surpasses 1.3540 for additional gains, a correction is likely.

JPY @ 157.80— The USD/YEN pair needs to surpass 158.85 to maintain its upward trajectory. However, there’s a possibility it could lose momentum before reaching that point. Support levels are around 156.50 and 155.70.

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