Having introduced the concept of compartflation here, we bring you the following ‘no-win’ situation for oil prices and the economy, as observed by Monument Securities’ Stephen Lewis on Friday:
…the interaction between oil prices and global demand is more complex than it was thirty years ago. Lower oil prices this year have helped to support households’ real incomes in the consuming countries and have contributed to the resilience of these households’ spending.
But, at the same time, they have cut into the incomes of oil producing countries, leading to cutbacks in their outlays. This matters more than it did in the 1970s because oil producers, in general, now have a higher propensity to spend their receipts from oil exports. Whereas, in earlier decades, the oil producers tended to channel their oil earnings into financial assets, recently they have been prompt in bringing forward capital spending projects to absorb surplus revenues.
Consequently, when the collapse in oil prices in the second half of last year depleted their revenues, the oil producers moved swiftly to scale back their spending on imported capital goods. This has been reflected in the extremely steep declines in capital goods exports of the developed countries. The process seems set to go into reverse over the next year, to the benefit of capital goods producers, if the oil price does no worse than hold around current levels.
The Achilles heel it seems was allowing all those oil export nations to reinvest their money in ‘forward capital spending projects’.
But more on that current oil price:
It is by no means certain, then, that end-user demand will support market forecasts of sustained strength in oil prices. This year’s rise in oil prices is more plausibly explained as a liquidity-fuelled advance, on the back of central bank asset purchases. As long as central banks continue to pump in liquidity, oil prices should stay firm. But as soon as their asset purchases cease, there will be a serious risk of oil prices breaking down.
Volatility it seems may well be with us for a while.
Related links:
Compartflation – FT Alphaville
Oil bulls – FT Alphaville
Oil, the great inflation hedge – FT Alphaville