The many macro-watchers in the oil markets are closely watching the exit strategies of the Fed and other key OECD central banks from their monetary expansion policies. Will interest rates be increased too soon and stifle a growth in demand? Do higher energy prices indicate that demand is already responding?
Bank of America Securities-Merrill Lynch analysts argue that monetary policy in emerging markets is the thing to watch. The recovery, they argue, is more about emerging economy demand than OECD demand, and continuing loose policy in countries with large numbers of consumers in the $5,000 – $20,000 income bracket – a “sweet spot” for energy demand – will be a crucial influence on oil demand. Meanwhile, some emerging economies, unlike their western counterparts, centrally control the supply of credit as well as the supply of money – so they have been able to boost the credit supply much more quickly than OECD countries.
At the same time emerging market consumers, BAS-ML says, are shielded from the worst effects of rising fuel prices by their currencies’ rise against the US dollar, and by government policies to subsidise gasoline. But developed economies have no such luck:
For consumers in the developed world, there is nowhere to hide. Higher oil prices could negatively impact terms of trade and partially offset the positive impact of lower imports on GDP growth (Chart 12). Moreover, higher oil prices will act as an important drain on disposable income for most of the developed world. Near-term, we do not believe oil prices will move sustainably above $80/bbl, a level that our economists believe could put the economic recovery in OECD countries in jeopardy. But a trend of rising oil prices over the next 18 months could pressure headline inflation higher in some OECD economies. This is because headline inflation is typically highly correlated with energy prices, even when core inflation remains subdued (Chart 13).
OCED central banks, they say, are trapped in a sort of double bind: raising interest rates will curb both demand and prices, while doing little to impact fuel consumption – which BAS-ML says will be more determined by transportation growth outside the OECD. In the end, they say, “OECD central banks may find that higher headline inflation is a more palatable option than another recession”:
What will happen next? This recovery is ultimately about a sustained expansion of domestic demand in EMs, not about a stellar comeback of the US or the European consumer. Thus, the exit strategy that may matter most could be that of the EM central banks, not the Fed. The BAS-ML economics team believes that EM market economies have robust growth fundamentals. But more importantly, our economists also believe that severe monetary policy tightening in economies like China is an unlikely outcome in the near-term (Chart 15). This disconnect between money supply and oil supply growth will again, in due course, create a situation of too much money chasing too few barrels of oil.
Which is, they say, part of what caused the problem in the first place:
But just as oil prices were an under appreciated cause of the global recession, we believe that the collapse in oil prices has been an under appreciated source of stimulus. Rising oil prices will take it away.