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13 January 2014
FX Daily: Lower oil prices: FX & asset market implications

While it is well known that a sharp increase in oil prices has preceded each of
the last six US recessions, like the dark side of the moon, what happens to the
US economy and key asset prices when oil prices decline is comparative virgin
terrain. Table 1 examines 4 episodes (1984, 1986, 1993, and 1997-1998)
where oil prices declined sharply, and this decline was not provoked by a
major US slowdown. 1986 is perhaps ‘the cleanest’ data, where excess supply
was dominant. In 1984, USD strength was a major oil price depressant in USD
terms. 1993 was partly a post Gulf War 1 response; and, 1997-8 included weak
Asian growth.
Past experiences of ‘favorable’ oil shocks
Table 1 above, looks at the annual change of relevant economic and financial
variables in the year before, the year of, and the year after these ‘exogenous’
(for the US) oil price declines.
On the real economy, there are obviously a multitude of factors impacting
growth and inflation, making it difficult to extract the oil price impact alone.
Nonetheless, a broad sweep of the data suggests:
1.

Growth was almost always at, or more often above trend, in the year
of and the year after the favorable oil shock.

2.

Core inflation went down marginally; total inflation inclusive of energy
prices not surprisingly fell more substantially.

3.

The mix of strong growth, with subdued inflation resulted in modest
declines in US 10 year yields.

4.

US credit spreads did not do a whole lot.

5.

Global equity indices were up sharply (well above the 9% 30yr annual
average for the World MSCI), while US equities typically also had
above average years.

6.

There was no clear pattern to gold’s performance. Outside 1993, CRB
industrials tended to follow oil prices down, a poor performance in the
context of US and global growth.

Policy accommodation
The extent to which the above variables react to softer oil prices was in no
small part a function of how the Fed and other policymakers responded to the
disinflationary forces. In 1986 the Fed cut rates. In 1993 the fed funds rate
remained at a cyclical nadir of 3%. In 1997-98, contained inflation allowed the
Fed to cut rates in the face of solid US growth to offset equity volatility
inspired by the Asia crisis. The past experience has then typically been one of
the Fed responding to softer oil prices with at least some accommodation that
supported asset prices, and furthered the divergence in asset and goods
inflation.
For the global economy, there are already elements of these forces at work.
China has played a disinflationary role for non-oil commodity prices in 2012–3.
A decline in oil prices will add to pre-existing disinflationary forces,
encouraging monetary policy complacency. Oil price declines tend to prolong a
favorable risk environment especially for the risky assets of net oil importers.
A policy accommodated decline in oil prices adds to the amplitude of the asset
cycle, initially on the upside, and eventually on the downside.

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Deutsche Bank Securities Inc.