Oil, Oil, Oil… It impacts our economy in several ways. We will take a look at the benefits and problems associated with falling oil prices and its impact on the U.S. economy. As volatile as the markets were last week it had nothing to do with oil… Okay, nothing is an over statement. Oil probably accounted for a mere 80% of the volatility.
While stocks were volatile last week it was not as overtly related to oil as in prior weeks. Sustained lower prices in oil were finally making themselves felt in some of the economic data released last week. In some ways it was good and in some ways bad, but the consistent theme was the drastic market reaction (in either direction) to the data.
The Good
As discussed in the past, the fall in oil prices has put more discretionary income into consumers’ pockets. For an economy whose GDP is based approximately 70% on consumption this swing in available discretionary income is crucial. Not to mention that it occurred during the all in important 4th quarter. Oil also helped GDP as the trade balance narrowed to -$39 Billion in November[2]. As oil prices fell the cost of imported oil fell and reduced our national trade gap. That gap is a drag on GDP, so reducing the gap improves overall GDP performance. Another notable fact is that this trade balance report is for the month of November. December is when oil took its largest hit so more to come.
Corporate earnings should benefit as well. Earnings season will get underway 1/12/15 and we will be able to see the impact of greater discretionary income at that point. Not only will it impact increased consumption, but also reduced corporate expenses. Cheaper shipping costs should translate to stronger profits as fuel expenses have fallen.
Lastly, as the U.S. economy picks up a head of steam, and the unemployment rate sits at 5.6% for December[3], it becomes more likely that the Federal Reserve Board (FRB) will raise interest rates. The key being, as the U.S. economy picks up steam we should start experiencing more inflationary pressures. The fall in oil prices has helped keep inflationary concerns at bay. As a result, this may prolong FRB action on rates. What may also be contributing to a lack of FRB action is that unemployment decreases were not only due to greater job creation, but also a falling participation rate.
The Bad
While easing inflationary pressures on a strengthening U.S. economy has been a good factor, the struggling European economy has slipped into deflation this past month, at -0.2%. It should be noted however, that when food and fuel are excluded (Core) that the Eurozone Consumer Price Index (CPI) came in at 0.8% year over year in December[4]. So fuel prices are having a large impact on their economies. Core CPI is tracked because of the volatility associated with food and fuel. So while deflation is absolutely a concern for the Eurozone, core inflation still exists.
The businesses that service the oil industry will suffer as a result of falling prices as well. As a reduction in exploration kicks in from the reduced profits of sub $50/barrel oil, cost cutting initiatives will be in full swing. Also shale producing oil efforts have a great breakeven point than traditional methods. The impact of lower oil prices creates more tension for this industry as opposed to traditional suppliers.
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[1] http://upload.wikimedia.org/wikipedia/commons/a/ab/Oil_platform_P-51_%28Brazil%29.jpg – This photo was produced by Agência Brasil, a public Brazilian news agency. In no way does my use of the photo suggest they endorse FFS, FAi or our use of the photo.
[2] www.investing.com – economic calendar
[3] www.mfs.com – week in review
[4] www.investing.com – economic calendar