Worsening US woes could hit Gulf economies

Alamy via Reuters

An ever-closer global banking crisis could spell pain for the economies of the Gulf region.

How so? US recession risk metrics have spiked since I published a column on this subject on June 26. 

Dr Copper, a proxy for the global industrial and construction cycle in the US and China, has fallen 20 percent since May. 

The $27 trillion US economy was only able to create a pathetic 114,000 jobs in July 2024, and the unemployment rate has edged up to 4.3 percent, but is headed higher.

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The ISM manufacturing index has fallen to an abysmal 46, which indicates industrial contraction amid an accelerating pace of plant closures, corporate layoffs, business failures and Chapter 11 bankruptcies. 

Debt defaults in the opaque $1.7 trillion private credit markets have already begun to rise.

Credit card delinquencies in a $1.8 trillion market are now at 2012 levels, when the economy was in recession and the unemployment rate was 8 percent.

The $1.6 trillion auto loan and $1.8 trillion student loan markets both exhibit distress.

Police records estimate that 20 percent of drivers in Florida cannot afford auto insurance. Food stamp usage has tripled. Consumer spending, 70 percent of the US economy, has stalled.

Federal Reserve chairman Jay Powell’s optimism about a soft landing for the American economy is contradicted by anecdotal evidence of retailer discounting, bloated inventories and CEO pessimism on the macro outlook in second-quarter earnings guidance.

If the Powell Fed is data driven, so are economists at major Wall Street banks. JP Morgan has raised its odds of a US recession from 25 percent to 35 percent, while Goldman Sachs puts the odds at 25 percent. The money markets now price almost certain odds for a 25-basis point Fed rate cut at the September FOMC conclave. 

The global economy is now in the early stages of a synchronised slump. A credit crunch is inevitable

In 2009 China was the world economy’s knight on horseback, after the systemic shocks triggered by Lehman, UBS, AIG, Bear Stearns, and the Irish, Spanish and Icelandic banking crises.

But a Chinese bailout is unthinkable in this cycle. The $18 trillion Chinese economy has been gutted by history’s biggest property market crash, a shadow banking crisis and a $20 trillion black hole in the balance sheets of provincial governments. 

About $3.2 trillion in bonds raised by offshore financing vehicles must be repaid by the end of 2024 alone, even as Beijing braces for new trade tariffs and an escalation of tensions in the South China Sea. China will thus export deflation to its Asian trading partners.

With Germany in recession, the global economy is now in the early stages of a synchronised slump. A credit crunch is inevitable at a time when global debt has risen to a staggering $342 trillion.

Global liquidity is the life blood of financial markets and risk asset valuations. The Bank of Japan has been the marginal provider of liquidity to global markets until early August, when it increased its policy rate to a mere 0.25 percent. That triggered a 30 percent meltdown in Japanese bank shares, while the Nikkei Dow index lost 20 percent in just three sessions.

Contagion and panic spread from Tokyo to Wall Street, Europe and the emerging markets at the speed of light, thanks to the hyper-volatile, hyper-networked electronic arteries of global finance.

Nasdaq’s mega-cap constellation alone lost $6.4 trillion in a single session. The Powell Fed pressured the Bank of Japan into a swift policy U-turn after the Dow plunged by 1,000 points and the volatility index hit a scary 60, last seen during the pandemic and the global banking crises of 2008-2009.

The Fed and BOJ band-aid was highly successful. The VIX, Wall Street’s pendulum of greed and fear, fell from 60 to 20 and the global equity markets regained their bullish ballast. 

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Yet investor psychology has been unnerved, because Wall Street knows it can no longer rely on the Bank of Japan as the world’s greatest liquidity spigot.

JP Morgan argues that three-fourths of the carry trade unwind is now over. But this is simply not true, since the entire Japanese banking system is one giant carry trade. Japanese banks have borrowed untold trillions of yen from domestic depositors, and invested/lent the funds abroad at much higher rates.

The Japanese government pension fund alone owns an estimated $1.8 trillion in global equities and bonds. Japanese life insurers and trust banks are among the world’s biggest investors in US Treasury bonds, British gilt securities, German Bunds, French OATs and even GCC sovereign bonds.

The Israel-Iran tensions and the US elections will add to volatility, as well as inflation and recession angst in the markets.

A US recession could be a game changer for GCC markets. Fed rate cuts will lead to steeper yield curves in the GCC and benefit bank stocks. 

If there is no protracted Mideast war or threats to the oil fields/tanker shipping choke points of the Gulf, crude oil prices could share the fate of Dr Copper and fall at least 20 percent.

This would represent a fiscal nightmare for the region’s major oil and LNG exporters.

A global recession will also mean lower FDI and bank credit flows to the GCC.

As in 2009, the currency pegs will pressure the burden of adjustment on GCC equities and property markets.

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