“If you repeat a falsehood long enough, it will eventually be accepted as fact.”
In the financial markets, and economics, it is a common occurrence for the media and commentators to latch onto a statement which supports a cognitive bias. They then repeat that statement until it is a universally accepted truth.
When such a statement becomes universally accepted and unquestioned, well, that is when you should probably question it.”
Last week, I had a conversation with a friend of mine about the plunge in oil prices in recent weeks. One of the biggest fallacies about plunging oil prices, and subsequently lower gasoline prices, is that it is a huge windfall for consumers. Even President Trump stated as much last Wednesday morning. To wit:
Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!
— Donald J. Trump (@realDonaldTrump) November 21, 2018
But is that really the case?
Oil prices are indeed important to the overall economic equation and, as I showed recently, there is a correlation between the oil prices and inflation, and interest rates.
“Oil is a highly sensitive indicator relative to the expansion or contraction of the economy. Given that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness…the chart combines rates, inflation, and GDP into one composite indicator to provide a clearer comparison. One important note is that oil tends to trade along a pretty defined trend…until it doesn’t. Given that the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which have a negative impact on the manufacturing and CapEx spending inputs into the GDP calculation.”
“As such, it is not surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates.“
We can also view the impact of oil prices on inflation by looking at breakeven inflation rates as well. As I noted in“Oil Sends A Crude Warning:”
“The short version is that oil prices are a reflection of supply and demand. Global demand has already been falling for the last several months and oil prices are now waking up that reality. More importantly, falling oil prices are going to put the Fed in a very tough position in the next couple of months as the expected surge in inflationary pressures, in order to justify higher rates, once again fails to appear. The chart below shows breakeven 5-year and 10-year inflation rates versus oil prices.”
