With ris­ing oil prices and rates, we are at last re­turn­ing to nor­mal­ity

The Sunday Telegraph - Money & Business - - Business - JEREMY WARNER

For fi­nan­cial mar­kets, the new year has got off to an un­set­tling start. Gov­ern­ment bond yields have risen sharply, and so too has the oil price, lead­ing some com­men­ta­tors to de­clare that we are at a new in­flec­tion point, with trou­ble ahead in mar­kets and the econ­omy. Is this just another, mid­cycli­cal squall, of the type we have seen sev­eral times be­fore in the cur­rent re­cov­ery phase, or does it presage some­thing more fun­da­men­tal and there­fore wor­ry­ing?

Start with oil. All of a sud­den, more or less ev­ery­one has turned bullish on the world econ­omy; de­mand is ris­ing at a time when Opec, to al­most univer­sal sur­prise, has been rel­a­tively suc­cess­ful at keep­ing the lid on pro­duc­tion. The other big fac­tor un­der­pin­ning a higher oil price is some­thing I’ve writ­ten about be­fore – the re­turn of a geo-po­lit­i­cal risk premium, tra­di­tion­ally thought to be worth some­thing like $10 a bar­rel on the price. This all but dis­ap­peared in the ex­cite­ment over bur­geon­ing US shale pro­duc­tion, which has made the world less re­liant on sup­ply from po­lit­i­cally un­sta­ble parts of the world. But now it’s com­ing back.

Pop­u­lar protest in Iran might em­bolden Saudi Ara­bia, now backed to the hilt by an seem­ingly bel­li­cose­minded US pres­i­dent, into do­ing some­thing really silly in the re­gion. What’s more, the US has been threat­en­ing new sanc­tions against Iran, which if im­ple­mented could again par­tially freeze Iran out of global mar­kets. There is also a big ques­tion mark over pro­duc­tion from Venezuela and Nige­ria. An­a­lysts may, how­ever, once again be un­der­es­ti­mat­ing the im­pact of shale, which with a re­cov­er­ing oil price is back to a “drill, baby, drill” men­tal­ity. US shale in­vest­ment, hav­ing been halted by the col­lapse in oil prices, is com­ing back, with US pro­duc­tion soon likely to sur­pass the 10m bar­rels a day mark. This phe­nom­e­non – that once the oil price gets past the shale break even point of around $55 a bar­rel, pro­duc­tion comes flood­ing back – puts a nat­u­ral ceil­ing on the price, mak­ing it most un­likely that oil will get back to past peaks, even with a fast grow­ing world econ­omy.

Add to that the bur­geon­ing num­ber of spec­u­la­tive po­si­tions that will shortly be look­ing to bank prof­its, and it may well be that oil uber bulls are again about to be dis­ap­pointed. That would be my bet. Re­mem­ber, oil still has the power to shock; if the price rises too far too fast, it could, by eat­ing into con­sumer spend­ing, up­set the global ex­pan­sion and tip the econ­omy into re­ces­sion. All too fre­quently, it’s hap­pened in the past. At this stage, how­ever, the rise is not big enough to bring the cy­cle to an end, nor does it seem likely it will be­come so.

Some of the same ob­ser­va­tions can be made about the cor­rec­tion in bond mar­kets, and the con­se­quent rise in mar­ket in­ter­est rates. Pri­mar­ily, this is about a “nor­mal­is­ing” world econ­omy, with in­vestors re­dis­cov­er­ing their ap­petite for risk. It’s also about the with­drawal of cen­tral bank mone­tary sup­port. So far the US Fed­eral Re­serve has man­aged this re­ver­sal well. Oth­ers may not be quite so sure footed. When cen­tral banks talk about en­gi­neer­ing a “soft land­ing”, they mean tight­en­ing pol­icy suf­fi­ciently to al­low for a safe de­scent, but not so fast it gen­er­ates a stall. Of­ten they get it wrong.

The risks are height­ened by a world econ­omy stuffed to the gun­nels with debt. We’ll see. Yet as with the oil price, it is very hard to see in­ter­est rates ris­ing back even to rel­a­tively tame pre-cri­sis lev­els, let alone the el­e­vated peaks of the past.

Dis­in­fla­tion­ary forces in the world econ­omy are still too strong. It’s al­ways right for in­vestors to worry; but it’s still too early to call an end to the cur­rent chap­ter of global growth. What we are see­ing in mar­kets is not so much the seeds of de­struc­tion as re­turn­ing nor­mal­ity.

‘Risks are height­ened by a world econ­omy stuffed to the gun­nels with debt’

A pump at a frack­ing site in San Joaquin Val­ley in Cal­i­for­nia. Amer­ica is said to have re­newed its ‘drill, baby, drill’ men­tal­ity

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