Are the Gulf States heading into higher interest rates and higher inflation?
If you live in a US dollar-pegged region like the Gulf States then interest rates have been relatively low for savers and moderate for borrowers. There have not been the ultra-low mortgage rates or the almost zero interest for savers.
Inflation has also been relatively low. Food costs have stayed static over the past year at least. The nastiest spike has been in energy prices both for autos and air-conditioning, a little ironic for an energy-rich region.
Gulf behind the curve
Because Gulf interest rates have not fallen like most dollar areas we should feel less of the impact of rising interest rates. This surely has to happen. In Europe we can see that the ultra-low official interest rate of the ECB has not prevented interest rates on Italian, Spanish, Portuguese, Irish and of course Greek debt soaring through the roof.
Yet there is a false sense of security about US bonds where the Fed still seems to rule over interest rates. Indeed, there is currently a flight to this perceived safety which is having the effect of keeping interest rates down. What could cause this blessing to reverse? And let us not be in any doubt this is all that is supporting the US recovery and stopping another slump.
Basically the same laws of economics that apply in Italy also do apply to the United States. Too much borrowing and you will always reach a tipping point when lenders force up the cost of borrowing, and that means a sudden escalation of rates.
Inflation is surely the thing to watch. For higher inflation means that US bond holders are actually losing money day after day at the moment. How long do you stay in a losing asset class? Perhaps only for as long as it seems to be losing less than everything else. Can we not imagine a reversal in which the money printing backfires and the banks begin to push that money into the economy and price levels start to move up rapidly. Then the US bond market will go the way of Italy and interest rates will spike upwards.
Asset price shock
That will not be good for asset prices. Those now supported by the Fed’s super-low interest rates will take a thrashing. Inflation of general prices would deflate investment asset prices.
Perhaps then in the Arabian Gulf countries it is no bad thing that interest rates have stayed relatively high in comparison with the US model. That should act as a buffer to rising US interest rates. But for those with investments in US equities, real estate and of course bonds this is going to be a very painful cold shower. Going into cash for the short-term never made more sense. Inflation is already moving up and interest rates cannot lag behind for long.