$47 a barrel.
That’s where benchmark U.S. crude oil futures were trading earlier this week. Just seven months earlier, they traded around $108.
For those of you not keeping score, that’s a plunge of more than 56 percent! Had the Dow Industrials dropped by the same amount in the same period of time, we’d be trading for less than 7,500, rather than around 17,500! That would put us within 1,000 points of the 2009 low that we saw in the depths of the Great Recession.
So as you can see, we’re not talking about chump change here. This is a massive move … in a key capital market … in a very short period of time.
But what about the U.S. economy? What about Federal Reserve policy?
Well, think back to the last time global oil prices collapsed in the late-1990s. Crude plunged to around $10 a barrel, and I remember (briefly) paying less than a dollar a gallon for gasoline on a trip to Georgia.
That was a windfall for the U.S. because our country was a much smaller producer of oil at the time. The shale oil and fracking boom was years out in the future, and domestic production was several million barrels per day lower than it is now.
This time around, things are somewhat different. Sure, lower gas prices are giving average Americans the equivalent of a “tax break” that years of QE didn’t. But both traditional oil-producing states like Texas and Oklahoma … and non-traditional states like Pennsylvania and North Dakota … are more levered to energy prices than they’ve been in a long time.
|The domestic energy boom has created thousands and thousands of jobs.|
The domestic energy boom has created thousands and thousands of jobs there. We’ve seen a spillover effect in regional housing and banking markets, and outperformance from those regional economies.
That’s going to go “Poof” if oil prices and production plunge, and energy-related investment peters out. One of the first spillover impacts came on Tuesday. U.S. Steel (X, Weiss Ratings: B-) said it would lay off 750 workers in Ohio and Texas because of falling demand for the tubular steel they helped produce. That kind of steel is used in oil and gas drilling.
Moreover, it’s not just countries that hate or dislike us who are suffering from plunging oil prices. There’s no love lost in Washington when nations like Iran or Venezuela are left to twist in the wind because of cheaper crude. Ditto for Vladimir Putin’s Russia.
But ostensible allies like Saudi Arabia and the UAE are increasingly suffering. Same for Brazil, Malaysia and even Canada. That country’s currency, the “loonie,” just plunged to its lowest level in almost six years! One investment bank recently estimated that the central Canadian government will lose $5 billion in revenue from plunging prices. Provinces such as Alberta, Saskatchewan and Newfoundland that rely on energy-related activities for as much as 30 percent of regional GDP will get hit particularly hard.
So sure, I’m as happy as you are to pay less at the pump. But if oil prices stay this low, or fall even lower, energy-related job and output losses could start hurting the U.S. economy … unless the “tax break” impact is enough to offset it.
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I’ve read differing analyses in that regard, and believe the jury is still out. But suffice it to say I’m less sanguine than many observers, and that’s one reason why I believe a policy response (say, surprise OPEC output cuts) is getting increasingly likely.
What about monetary policy? How will falling energy prices impact that? Well, they will drive headline inflation lower since energy prices are a major component in the Consumer Price Index. The sharp rise in the dollar will also act to curb import inflation.
The Fed generally ignored energy prices and the dollar when the former were rising and the latter was falling, claiming the “core” rate of inflation was much more important. But will policymakers do the same now that the roles are reversed? Or will they start dialing back their recent talk of impending rate hikes?
I believe we’ll get some key clues over the next couple of weeks as Fed speakers take various podiums to add their views. We’ll also have more data on employment to work with, not to mention a possible major move on the policy front in Europe with the ECB getting closer to pulling the trigger on open-ended QE. But suffice it to say that it would take a lot to sway the Fed from the path it has spent a few quarters mapping out.
So stay tuned! The month of January is shaping up to be a biggie for the markets, and I’ll do my best to help you navigate it as smoothly as possible!
Until next time,