Recent falls in commodity prices have surprised investors, with many struggling to understand the drivers behind the moves and what it could mean for the global economy. While a supply-driven fall would broadly be good news for developed markets and bad news for commodity exporting emerging markets, a demand-driven slump could prove negative for the global economy as a whole. So what impact are these price fluctuations likely to have on regions and central banks? The answer here depends on individual economies.
What is driving price falls?
In contrast to last year, when excess oil supply arguably drove the fall in prices, the dynamic behind the current situation is somewhat different.
Undoubtedly, the ongoing slowdown in China is a contributing demand side factor, as its economy continues to rebalance from investment towards consumption. This slowdown from double-digit growth rates is to be expected and should be seen as a good thing for the country over the longer term, as it is crucial its growth model becomes more sustainable. However, this adjustment is a headwind to the global economy overall, with commodity exporters the biggest losers in the process.
Central banks will be watching closely
Commodity price falls also pose a dilemma for central banks, particularly the US Federal Reserve as the one set to start its hiking cycle first and as lower inflation figures complicate the decision on when to do so.
Low inflation was expected to subside towards the end of this year, as the oil price decline dropped out of the figures and base effects kicked in. However, as commodities have sold off again, the Fed faces the prospect of a longer period of low inflation, which could reduce the incentive to hike earlier rather than later.
Rate rise decisions are also being complicated by global factors such as Greece and China. An abrupt slowdown in China’s economy while inflation is pushed lower by the resulting fall in commodity prices could represent a double blow to the prospect of any Fed hike this year.
While the US economy is not yet at full capacity, the UK looks to be much closer to this limit, with wage growth having picked up over the past couple of months. Despite a decent growth picture in the UK, sterling strength and the associated downward impact on inflation potentially gives the Bank of England scope to push out rate rises well into next year, until after the Fed makes its move.
Emerging markets vulnerable
Among commodity exporting emerging markets, Russia and Brazil face the most difficult adjustment. In both countries, the negative impact of the price declines is aggravated by an unfavourable political backdrop. In Russia, sanctions related to the conflict in Ukraine are certainly biting, pushing the economy deeper into recession. Meanwhile, in Brazil, political scandals combined with continued heterodox macro management are also weighing on growth and sentiment. In the world of low commodity prices, structural reform is key for successfully rebalancing towards more productive sectors of the economy. So far, however, neither country has made any material effort to get out of the “resource trap”. Both will continue to struggle for now.
I expect this volatility to continue over the next few months, while markets are getting to grips with global growth prospects. The recent moves in commodities are important for investors but they are not likely to significantly change the overall outlook for global growth – at least for now.
I still believe the second half of this year will bring moderately faster and more synchronised growth across the world. Inflation remains low for now, removing immediate pressure from central banks to start tightening policy. The Fed and the BoE are still likely to be the first major central banks to hike rates over the next few months. Similarly, China’s ongoing transition to a more consumer driven economy continues, with its impact on demand for commodities as clear as ever. We are likely to see some further volatility as this process unfolds but, overall, China’s economic outlook remains positive as it strives towards a more sustainable growth model.
Anna Stupnytska is global economist at Fidelity Solutions.