Can GCC keep pace with Fed's tightening actions?

Can GCC keep pace with Feds tightening actions?
The GCC currencies' peg to the dollar has been a long-term priority.

Dubai - There is upside for one important sector: banking and finance

By Hussein Sayed

Published: Sat 1 Apr 2017, 4:19 PM

Last updated: Sat 1 Apr 2017, 10:10 PM

The gcc's monetary policy of keeping up with the Joneses is firmly in place. It is steadily tightening, in line with the Federal Reserve's latest rate increases. On March 16, the bloc's central banks hiked interest rates by 25 basis points right after the Fed did. Although the GCC currencies' peg to the dollar has been a long-term priority, this time, there are still pockets of weakness in global crude oil prices. This means that growth in the GCC may not keep up with monetary tightening. Moreover, higher interest rates have a chilling knock-on effect on borrowers. Those who can't stand higher borrowing rates are left out in the cold. Small-to-medium enterprises in particular are feeling the squeeze. Faced with the steadily rising bank rates, these businesses have some tough decisions to make. Some may decide to sacrifice growth for savings on interest payments.
It's a puzzle currently faced by many sectors of the economy. Since tightening began at the start of 2017, businesses in the tourism sector face the challenge of a higher dollar making destinations like the UAE more expensive. This pressures tourism revenues and growth plans. With further interest-rate hikes expected throughout the year, pressures on the tourism sector are likely to increase.
On the other hand, there is an upside for one important sector: banking and financial services. Higher interest rates are good for the banking sector. That's why US banks are benefiting the most from the tightening cycle, as their margins are higher. But US fundamentals are more robust than the GCC bloc. The economy is more diversified and unlike the GCC countries, is not in the middle of extensive reforms. So, for the GCC countries' banking sectors, increased interest rates may not lead directly to higher margins. This is because the main factor to consider is not margins, but the willingness of companies to borrow. It's true that deposits and demand for bank bonds may increase because of the more attractive yields. Still, this doesn't feed into income from borrowing rates.
Foreign investors are likely to be attracted by higher interest rates in the GCC countries. But then again, there is a drawback for government-issued debt. Considering the higher yields, debt issuance is expected to fall. This means reduced income from sovereign bonds at a time when revenue is needed for diversification. The more hikes there are this year, the more sovereign debt will cost the GCC states in the future.
For investors, this is the time to focus on careful risk management and portfolio balancing. The dollar still faces volatility. It has been the focal point for markets after dropping in the wake of the Fed's latest rate hike. The currency is on track for its longest losing streak since early November. While this could provide short-term relief for industries like tourism in the UAE, it's not likely to last once the Fed gears up for another hike. Who would have believed that the dollar would suffer steep losses after the Fed tightens? In fact, the dollar was a crowded trade. Feverish expectations were built around a faster tightening cycle, but latest FOMC minutes proved they are not in a hurry. Investors who want to gauge the dollar's direction should analyse the yield curves and spreads between the US and the rest of the world. Talking of expectations, the first quarter is drawing to an end with no fiscal stimulus in sight in the US.
So far, it seems now that President Donald Trump has over-promised and under-delivered on tax cuts and infrastructure spending. This has weakened the dollar, which is not a bad thing for GCC export prices or tourism. If the Trump administration's fiscal stimulus is launched in the second quarter, I expect interest rates will be pushed higher along with yields on US Treasuries. This would force the Fed towards more tightening, and thus a stronger USD. If I were to sum up the effect of tightening in the GCC economies in one word, it would be "unpredictable". Investors and traders ought to plan around the upsides and downsides, with an eye to mitigating the risks.
The writer is chief market strategist at FXTM. Views expressed are his own and do not reflect the newspaper's policy.

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