Oil prices are already down about 30 percent since June, and with
little consensus about the likely outcome from a meeting of
ministers from the Organization of the Petroleum Exporting Countries
meeting on Nov. 27, a snap back seems unlikely and a further trend
decline very possible.
This is an unusual oil price fall, and one which is more about a
structural change in markets, though it has come along with some
weakening in economies in Europe and Asia. The prime and lasting
underlying causes are vast new energy supplies coming online in the
U.S., notably shale oil, and the fading impact of production
disruptions in places like Libya. This implies lower energy prices
for a good long while.
“Oil markets have witnessed a structural change,” Michael Haigh,
global head of commodities research at Societe Generale, wrote in a
note to clients.
“We believe that we’re in the middle of a very fundamental change in
the oil markets, the type of change that only happens every decade
Haigh sees a real possibility, perhaps a 40 percent chance, of oil
hitting levels of $70 a barrel for Brent crude and $60 to $65 for
U.S. Texas light sweet crude.
In many ways a fall in oil is great medicine for the particular
problems in the global economy now. While monetary policy has
ballooned the value of stocks and bonds, those who own them are
generally already well off and only spend a limited amount of their
In contrast, drops in energy prices act as a stimulus by putting
money into the pockets of those without large retirement accounts or
According to SocGen estimates every fall of $20 per barrel in the
price of oil boosts global growth by about a quarter of a percentage
point in the following year.
All else being equal, a boost in growth should be helpful to riskier
assets like stocks.
This is not to entirely set aside concerns that falling energy
prices reflect deteriorating economic fundamentals. They in part do,
and to the extent that issues in, for example, China, Japan and the
euro zone worsen, it is quite possible that we see weak energy
prices and falling or volatile global markets.
LOWFLATION AND CENTRAL BANKS
In part predicting the impact of lower energy prices on financial
markets is difficult because of the ways in which they might
complicate economic management and monetary policy.
With West Texas oil trading at about $76 per barrel, the impact on
consumer price inflation in the coming year should be substantial.
“If oil stays at $75 per barrel, which I think it will, CPI should
probably go to zero. Zero,” leading bond fund manager Jeffrey
Gundlach of DoubleLine Capital said on Monday.
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That is a far out-of-consensus view, even if from a leading bond
fund manager, but nonetheless the base issue is clear: too little
For riskier assets, this is a double-edged blade. Inflation has
persistently been below the Fed’s 2 percent goal, and with the
impact from oil feeding through to core inflation as well, it will
be hard for the central bank to raise benchmark U.S. interest rates
in the coming year.
Low-priced oil then can extend the bull run, both by improving
fundamentals and by extending the period of extraordinary monetary
This is not simply a U.S. issue. While lower taxes on oil in the
U.S. make the impact of falling prices on inflation greater there,
to the extent that the Bank of Japan or European Central Bank are
simply fighting deflationary psychology, it will also prompt easier
policy from them as well.
A bit of unexpected support from monetary policy plus an economic
stimulus seems like good news for stocks on its face, but this kind
of thing is only helpful in limited doses.
Remember the Fed has been using extraordinary tactics for several
years, and yet while the job market is doing reasonably well,
inflation looks too low for comfort.
Investors could easily decide that things globally are starting to
look too Japanese for comfort. Anything which brings looser monetary
policy is good for markets so long as it doesn’t also undermine
faith in monetary policy’s power.
On balance, lower oil prices are a boon, though a boon with
small-probability but perhaps high-impact risks.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
firstname.lastname@example.org and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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