Market Nugget – Opinion
Rising energy prices present the same drag on the economy as rising interest rates. .Although you can make a good argument that rising oil prices are inflationary, interest rates may not respond as expected - why?
The most obvious reason is the recycling of petro-dollars. The higher the price of oil, the more dollars there are sloshing around in the oil exporting countries looking for a place to call home; this is especially true the longer oil prices stay high. Initially those petro dollars are put to work at home but eventually there are so many surplus dollars that they find their way back to the USA.
Those petro-dollars are now joining China’s and other countries US trade deficit dollars in being recycled back into the market via demand for US Treasury securities. This added demand for US Treasury securities is helping to offset the massive supply of treasuries and is keeping pressure on interest rates to the downside.
Connecting the dots, in roundabout way high oil prices may be helping to support the overpriced housing market via their impact on interest rates. Of course, this is not sustainable – the higher oil prices will constrain economic growth which will impact housing….eventually.
A slower economy should create some slack in the demand for oil , which should negatively impact oil prices. The double whammy on oil will come when a slower economy teams up with increased oil supply capacity, capacity that is built and brought on stream in direct response to the current high price of oil.
All commodity price booms sow the seeds of their own demise in the medium term. Oil is unique in that it is becoming finite in supply and hence in the long run oil there are genuine supply concerns, we are not there yet. In response to high prices in any commodity (oil, iron ore, steel, grains), money is invested to increase capacity in a desire to cash in on the higher prices.
The commodity cycle has always been characterized by very high highs and unbelievably low lows. This is because typically the bulk of the new capacity will come on stream just as economic growth is slowing partially as a result of the high commodity prices. Economic booms start when commodity prices are low and end just as, or just before, commodity prices peak.
Looking at the US economic environment today it is ironic that a declining price of oil may also be the cause of rising interest rates – when the petro-dollars no longer find their way back to the US Treasury market. It is an economic cycle unlike others; the forces of deflation are in abeyance as long as commodity prices are rising.
Also, as interest rates rise, I suspect other asset prices (stocks and real estate) will have difficulty remaining at levels fueled by ultra low interest rates and previously higher rates of economic growth. Take away asset price inflation and the worldwide glut of productive capacity may once again allow the deflation genie to escape from its bottle. |
