Collapse In Oil Prices Have Taken The Pressure Off Of The Fed

By Bryan Rich

November 27, 5:00 pm EST

Earlier this month, we talked about the big fall in oil prices.

If we look back over the past five years, the magnitude of that move is only matched (or exceeded) in cases where there was significant manipulation in the oil market and/or a systemically threatening oil price crash.

As we’ve discussed, the pressure on oil this time around seems to be about manipulation — and appears to have everything to do with Trump’s leverage over the Saudis (related to sanctioning the Kingdom over the Khashoggi murder).

But we’ve now traded down to the important $50 mark.  That’s 35% from the highs of just October 3.  And this is an inflection point where it could go bad, but it also could present a goldilocks scenario (a level that’s just right for the U.S. economy).

Sure, cheap oil is good for consumers.  You save a few extra bucks at the pump.  But in the current environment, it presents risks to the financial system.  The shale industry’s break-even point on producing oil is said to be $50.  Below that, they dial down production, lay off workers, stop investing and quickly become a default risk to their creditors (U.S. and global banks).  We saw it back in 2016.  The same can be said for those countries heavily dependent on oil revenues (i.e. they become default risks as oil prices move lower).

That’s the bad side. The good side to the oil price slide?  As we’ve discussed, it should relieve some pressure on the Fed. The Fed likes totalk about their inflation readings excluding effects of volatile oil prices.  But they have a record of acting on monetary policy when oil is moving.

The bottom line: Oil plays a big role in their view on inflation.  And given the quick drop in oil prices, the Fed’s concerns about inflation should be cooling. Again, this opens up the door for the Fed Chair, tomorrow, to take the opportunity in a prepared speech at the Economic Club of New York, to signal a pause coming in the Fed’s rate normalization program. That would be a positive catalyst for economic and market confidence.

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