- The drop in oil prices has not been welcomed with open arms in all corners…
- …the strong correlation with bond yields could reflect worries about demand and deflation…
- …but we think that the impact will generally positive, while lower inflation will be transitory
Oil price collapse from a pessimistic point of view
Not everyone is happy with a huge tax cut apparently. The more than halving of oil prices over recent months has received mixed reviews in some quarters. The negative tilt is that the fall in oil prices may be reflecting a weakness in global demand, while also encouraging deflationary tendencies. There is no pleasing some people. Presumably if oil prices had doubled, they would be throwing a party.
Government bond yields correlated with oil prices
One of the remarkable features of recent financial market moves is the strong correlation (close to 1 for Bunds, 0.84 for Treasuries) between oil prices and government bond yields, which have fallen in unison. This may reflect worries about demand, lower inflation expectations, and expectations of ECB sovereign bond purchases.
We expect low oil prices to support demand
In our view, the decline in oil prices will provide a significant boost to economic growth over time, with net importers benefiting from a large windfall (see chart). This includes the US, eurozone member states and Asia’s largest economies. In addition, although inflation has further to fall, it will likely bounce back towards the end of the year, as the oil price effect dissipates. We do expect the ECB to announce large scale asset purchases, likely this month, which should also be supportive for the economy. The US experience suggests bond yields mainly fall in the run-up to QE, and we think much of the effect is already priced in.
US small business owners more confident and plan to increase wages…
Meanwhile, data out of the US was generally positive. The small business optimism survey crossed the 100 mark in December, reaching 100.4, the highest level in nearly 14 years. Even more encouraging, one of the components of the survey showed that a quarter of the small businesses had increased wages in the past few months and that 17% of them had plans to increase it further. This is in contrast to another wage measure released last Friday, which was weak, but often subject to revisions.
…while job openings point to further tightening of the labour market
Meanwhile, another report which is closely watched by Fed policymakers for signs of labour market improvement, showed job openings increased to 5.0 million in November compared to 4.8 million the previous month, now up 20% relative to a-year-ago levels. Job openings increased across the board. Other details of the report showed that the hire rate edged down to 3.3% compared to 3.7% the previous month. The number of quitters, which includes workers that are willing to leave their jobs for better opportunities was unchanged from the previous month, at 1.9%. Most evidence suggests that slack in the labour market is diminishing.