Are lower oil prices good or bad? Robert Spector, CFA, Institutional Portfolio Manager, Sanjay Natarajan, Institutional Equity Portfolio Manager, and Robert M. Hall, Institutional Fixed Income Portfolio Manager, from MFS, answer this question through a recent investment view.
In a year full of macro surprises, the sharp decline in the price of crude oil is the latest development to make headlines. Roughly one year ago, the consensus forecast for the end of 2014 was $100 per barrel for West Texas Intermediate and $110 for Brent crude — a miss of about 30% compared with current prices around $70. “As if on cue, many have been ready to describe how absolutely wonderful the oil price plunge can be for the global growth outlook”, highlights the report.
Winners and losers
To be sure, there are bound to be pockets of the global economy that will benefit from lower energy costs. When all the positives and negatives are balanced out, we can likely expect a net boost to global growth relative to what we would have seen with $100 oil. Then again, it was weak global growth —alongside oversupply— that was a key contributor to falling crude prices in the first place, so the argument becomes kind of circular, highlight MFS' portfolio managers.
“We prefer to think of the oil price drop as stimulative overall, similar to a tax cut. Declines in the price of this or any other commodity help distribute growth away from regions that are producers toward those that are consumers. On balance, the net benefits to China, Europe, Japan and the United States could outweigh the hits to activity in Canada, Norway, Russia and above all the Organization of the Petroleum Exporting Countries (OPEC), where the erosion in terms of trade would impair domestic incomes, currencies, government revenues and capital spending plans”.
The drop in oil prices will put more downward pressure on already low global inflation, pushing some countries — namely, the United States and the United Kingdom — further away from their inflation targets and others — including the eurozone members — closer to mild deflation.
“Again, this acts in the same way as a tax cut to boost real consumer incomes. But when growth is weak and debt levels are high, any negative shock to nominal growth and persistently low inflation expectations could be bad for fiscal trends and rekindle concerns about debt sustain- ability — a potential risk for Europe”.
Implications for central banks
The impact of falling oil prices on inflation provides central bankers with yet more justification to keep the liquidity taps wide open. For the US Federal Reserve, which is expected to raise rates at some point next year, muted inflation pressures via lower oil prices tend to offset the effects of tightening labor markets. Should the Fed choose to postpone the anticipated rate hikes, this may be its excuse, states MFS.
The European Central Bank (ECB) will probably move toward outright sovereign bond purchases next year in its effort to fight deflation, while the Bank of Japan may maintain its easy money stance as inflation drifts away from its target. The combination of low inflation and slowing growth has already spurred the People’s Bank of China (PBOC) to take action with its first rate cut since 2012, with more likely to come if growth and inflation remain weak.
"In short, we would avoid becoming overly optimistic about the impact of falling oil prices on the global macro environment, as certain producing economies are likely to be hit pretty hard and the latest down-leg after OPEC’s decision not to cut output quotas could tip Europe into a mild deflation. Nevertheless, when the positives and negatives are netted out, and given other sources of stimulus already in place, there may be enough global growth in 2015 to support the valuations in risk assets", concludes the report.