US Interest Rates and Arab Markets: The Decisive Week

The equation facing investors is no longer limited to the strength of U.S. growth. The problem is that the continued resilience of the labor market and consumer spending, coupled with slowly declining inflation, could turn the economy's strength into a source of pressure. This would keep monetary policy restrictive, push bond yields and the dollar to higher levels, and transmit this wave to financing costs, asset prices, currencies, and commodities outside the United States, including Arab economies.

Attention is focused on the September jobs report, scheduled for release on Friday, October 2nd, as well as the Personal Consumption Expenditures (PCE) data and job openings data due on Wednesday. These figures will put markets to a direct test to determine whether the U.S. interest rate hike in September marks the beginning of a new tightening cycle or a step after which the Federal Reserve can pause.

Reuters polls expect the U.S. economy to add about 100,000 jobs in September, with unemployment rising to about 4.2%. These expectations follow a strong surprise in August, when the economy added 162,000 jobs compared to only 21,000 in July, while the unemployment rate remained steady at 4.1%. The comparison reveals a labor market that has improved significantly after a period of weakness, but it is not enough on its own to confirm a return to a hiring boom, especially since the average monthly increase over the previous 12 months did not exceed about 31,000 jobs.

However, the Gulf picture is not one-directional; rising interest rates pressure credit and assets, while high oil and gas prices can provide public finances and external positions with a greater capacity to absorb the shock. Conversely, a stronger dollar and higher global interest rates weaken demand for commodities and global growth, creating a counter-force that could pressure energy prices.

The transmission channel of the shock appears different and more sensitive in Arab economies with large external financing needs. In Egypt, the Central Bank kept interest rates unchanged last Thursday for the third consecutive time, at 19% for deposits and 20% for lending, despite urban annual inflation falling to 14.5% in August from 14.9% in July. In contrast, core inflation rose slightly to 14.9% from 14.7%.

If U.S. data pushes the Federal Reserve toward further tightening, higher U.S. yields and a stronger dollar could reduce Cairo's room for maneuver. Higher yields on U.S. assets increase the return investors demand to hold emerging market debt and raise the cost of external borrowing, while a stronger dollar could exert additional pressure on the cost of imports.