Brent crude oil fell to below $27 per barrel last week before rebounding to just over $30 dollars, levels not seen since 2003. Historically, lower oil prices have bolstered domestic growth, acting as a tax cut for consumers who could fill up their gas tanks for less money. Since much of the oil consumed in the United States was imported, the benefit to consumers outweighed the damage done to domestic oil producers. Today, economists are discovering that this relationship may no longer hold. Oil and gas production in the United States has increased markedly in recent years, so much so that the pain felt by U.S. producers is overshadowing the windfall to consumers, leading energy companies to decrease capital spending and lay off workers. In fact, according to the United States’ Energy Information Administration, only 27% of the petroleum consumed in the U.S. in 2014 was imported, which is the lowest level since the mid-1980s (see graph). Compounding this trend has been an increase in the propensity for saving. As we touched on in last week’s market update, the savings rate in the United States has ticked up from 4.4% at the end of 2013 to 5.5% at the end of 2015, an indication that consumers are still sitting on the sidelines. This has led several economists to downgrade their estimates for economic growth in 2015 and beyond. JPMorgan Chase, for example, predicted last January that lower oil prices would add approximately 0.7% to GDP in 2015, but they have since revised their estimate down, asserting that lower oil prices may have actually subtracted 0.3% from GDP. However, more so than economic growth, this is a story about inflation. The Federal Reserve has made it clear that the level of inflation will drive its monetary policy decisions in 2016. Given the sustained fall in the price of oil, the Fed’s job is becoming increasingly difficult. The market seems to agree, now pricing in just a 30% chance that the Fed will raise rates again in March. All of this leads us to believe that any additional rate hikes in 2016 will be slow and measured in nature.
Source: NY Times, U.S. EIA