A Year in Review – The Fiscal Cliff’s Effects on Global Markets

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The fiscal cliff in the United States was the hot topic surrounding domestic economic policy throughout 2012, as my colleague Ian Mathieson discussed in his year in review last December. It is safe to say that the same was true for this year as well. The global markets were once again on their toes observing the roller coaster of events unfold as US lawmakers combated the nation’s growing deficit, while instigating a bigger battle between each other. The decisions and policies implemented in 2013 have cause to predict a different outlook for the US economy and global markets.

Shutdown and the Market

Failure to reach an accord on time for the 2013-2014 financial years’ budget meant that there were no proper means to allocate state related funds. As a result, a government shutdown occurred for the first time since 1996 (Bloomberg). Public information sources halted publishing and commodity prices reacted accordingly to the turmoil. The EIA stopped releasing energy and commodities information causing market participants to rely on less complete data publications which jeopardized the quality of their analysis (Platts). Global commodities continued to move with the laws of supply and demand as base metals, such as copper, took a downward hit due to uncertainty of US imports (OGJ). Similar trends were witnessed in WTI and Brent futures following fears of decreased demand from oil’s number one consumer.

Weekly US crude imports began decreasing upon the October 1st shutdown along with WTI and Brent prices. The post shutdown months saw WTI and Brent prices increase with US demand as the economy began rebounding.

Figure 1: Weekly Crude Oil Imports in the US from EIA is compared with NYMEX WTI and Brent Settlement Prices for the months before and after the government shutdown period

Moreover, congress’s eventual budget agreement was one of the global factors that saw further downward pressure on gold prices until the years end. Upon signs of a strengthening economy, the Federal Reserve’s plan to end Quantitative Easing (QE) and increase interest rates lead to higher confidence in the dollar and less demand for safe haven commodities (Bloomberg).

Figure 2: NYMEX Gold Settlement Prices compared with the Federal Reserves Effective Rate for the months before and after the government shutdown period

Easing the Deficit and the Mind

The end of the year QE tapering initiative is set to decrease US Federal Reserve purchases of government securities by $10 billion every month. QE’s success, being heavily dependent on positive market sentiment, saw that falling interest rates increased borrowing and spending throughout this past year, resulting in the creation of over 200,000 jobs (Bloomberg).Tapering is deemed as the first step towards ending a five year economic recovery policy and its potential implications have yet to be seen on the commodities and global markets.

The domestic economy’s position today is clearly much different than it was one year ago. Whether the Federal Reserve’s QE policy is directly responsible for this improvement is still a subject left for debate. Analysts have often viewed QE to be a testament to psychology rather than an actual complex macro-economic tool (Time). Regardless of whether the market optimism was a result of QE or just the easing of investors’ minds, it can be expected that the process of removing this policy will be closely watched around the world in 2014.

The Outlook

There is little doubt that political and economic activities in the US are key influencers on commodity markets. If the agreement on the new budget and the QE tapering initiative continue their course, the outlook for 2014 could be positive for Washington while potentially increasing the risk of uncertainty for other global markets. It is hard to determine how tapering will affect commodity prices in the following year. Aside from the downward pressure on prices during the government shutdown, there has been a general increase in commodity prices since the inception of QE and strong economic performance from emerging nations (FT).

The emerging nations that have actively been involved in fiscal expansion policies- which are increasing their national deficits- have potential to be hit hardest from QE tapering (Bloomberg). US interest rates are set to increase over the next year to provide higher domestic return on investments; concurrently, this gives cause to decrease the amount of capital inflow to emerging markets (FT). Decreasing investments will result in currency depreciations for these nations, likely resulting in alterations to their import and export policies (Forbes).

Brazil and South Africa, emerging nations to take on fiscal expansion (Dupress), have seen their currency appreciate in value in the months prior to and during the US government shutdown. As talks of tapering continued through the end of 2013, there was a clear contrast in the markets behavior with restored confidence in the US dollar.

Figure 3: The Federal Reserves US dollar comparison with the Brazilian Real and South African Rand for the months before and after the government shutdown period

Similar to last year, political and economic decisions in the US are once again dictating global market reactions. To account for the coming years changes in managing the fiscal cliff, emerging nations may need to re-evaluate their current economic policies to prevent recessionary conditions. Regardless, investors can benefit from timely and accurate market information spanning all points of the globe to minimize their risks.

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