The release of the minutes from the latest Federal Reserve meeting received a mixed reception, some analysts concerned that the Fed indicated it will stick to their desire to raise rates four times this year despite growth fears, others that the cautious inflationary comments will mean the Fed will ultimately be more circumspect. The market is often the best commentator when deciding what is correct. The US dollar fell modestly against its basket of currencies, that would suggest favouring the more dovish comments. The treasury market hardly moved, yields on the 2-year treasury have fallen from over 1pct at the start of the year, to just over 0.8 of a pct. as of last night. The market is pricing in between one and two rates rises this year, and the minutes did not appear to change that view. We think the Fed will not move to four, the oil price will keep inflationary pressures down and the market will be correct, it usually is!
We have pointed out in the past few weeks the correlations between the oil price and equity markets. Just to demonstrate how the correlation seems to be continuing, equities in the US initially reacted more positively to a rising oil price on the back of production cut speculation, than another piece of poor economic data in the form of weak durable goods orders.
The FT on Wednesday demonstrated this correlation has recently reached almost 100%. The article makes the point rightly that low oil prices are good news for the consumer, and as most developed economies are consumer driven therefore this is good news historically for developed economies. Given this, why are equities falling with the oil price? If one studies a long term chart of oil prices and recessions going back to the fifties, without fail a spike in the oil price leads to recession. Each time the price then falls and the recession ends and the global economy recovers. Interestingly the one time this has not so far appeared to be the case was the recovery in 2009 of the oil price back to $110 a barrel in the following years. It could be argued this may be because of the amount of money central banks were pouring into the global economy.
Many analysts claimed when QE was introduced, all it would do was boost the commodity prices. Many economists dismissed that theory. Could it be that despite many who questioned this idea, the rising oil price was after all a direct result of the Fed’s monetary policy? Looking back the oil price and the Fed’s monetary policy seem as correlated as the equity market currently is. There is no other real explanation for the rise that we can think of. If the US does enter a recessionary phase, it could well be as a delayed reaction to the oil price rise. What ever the reason for the rise and fall in the oil price over the past 5 years, in our opinion a lower oil price has to net benefit the global economy.
On Thursday a quick reminder of the damage lower oil can do to emerging economies, the World Bank as the IMF and World Bank fly out to Azerbaijan to discuss a $4bn emerging bailout.