24 Jun 2005 Oil Back in the Driver’s Seat?
Until Monday, investors seemed little interested in rising oil prices. But oil’s crossing of the $60.00 threshold rattled more than a few. Stocks declined for the past four days as oil prices increased. When the price of crude briefly crossed $60.00 yesterday for the second time this week on the New York Mercantile Exchange, even more headed for the exits. FedEx didn’t help matters as they reported earnings that fell short of expectations; blaming high fuel process for some of their problem. The DOW was down 1.6% and the broader S&P 500 was down a little over one percent.
Many experts agree that the recent oil price surge is due to excessive speculation, but there seems to be enough demand, tight supply and limited refining capacity to keep a high floor under prices. The renewed question on investors’ minds is, will oil prices in the $50-60 range have a significant impact on economic growth? So far, with the exception of a few oil-dependent industries the answer has been no.
Also on Monday we learned that the Index of Leading Economic Indicators declined by a half of a percent. That was the fourth drop in the past five months. The only positive contributor among the index’s ten components was the stock market. However, the Leading Index has not been a good predictor of economic growth for the past several years. Experts say that one possible reason is that the index’s money-supply component doesn’t track modern liquidity sources. And while a shrinking spread between short- and long-term interest rates has always been a bad sign for the economy in the past, some economists, including Alan Greenspan, have lately said things could be different this time, according to the Wall Street Journal.
Last Friday, the Commerce Department said the current account deficit, the broadest measure of international trade, opened wide to $195.1 billion in the first quarter, a new record, or 6.4% of U.S. gross domestic product, also a record. The gap was on a pace to stretch to $778 billion this year, trouncing last year’s record of $668 billion, or 5.7% of GDP. The common wisdom is that the gap hurts U.S. economic growth, as Americans give more of their hard-earned dollars to foreign manufacturers, while U.S. manufacturers wither on the vine. But Ken Tower of Charles Schwab’ CyberTrader unit argues “the trade deficit has been hitting record levels regularly since I entered the business some 312 months ago, and the Dow is up about 13 times since then. Let the economics professors and politicians wring their hands with worry … As far as I can tell, for the past 26 years a record trade deficit is bullish.”
China is the latest scapegoat for the trade gap and many economists and politicians are decrying the loss of jobs to that fast-growing nation because of unfair trade policies. Yesterday, Federal Reserve Chairman Alan Greenspan warned the Senate Finance Committee that throwing up barriers to Chinese trade could be detrimental to the economy’s health. “A policy to dismantle the global trading system in a misguided effort to protect jobs from competition would redound to the eventual detriment of all U.S. job seekers, as well as millions of American consumers.”
Today’s headline for durable goods orders shows an increase of 5.5% in May which is great news if it were spread throughout the economy. But the biggest part came from very large airplane orders for Boeing. Demand declined for business equipment suggesting corporate investment isn’t improving. While the economy appears stable, growth is sluggish and likely to remain so for some months to come.
In our judgment, the Fed still holds the cards. Higher oil prices might stall the economy if they stay at current levels or rise, but if they decline from here monetary policy makers gain some free help in keeping a lid on the economy’s growth. Just how much higher the Fed opts to take interest is uncertain. Adding to the uncertainty is just how aggressive Mr. Greenspan plans to be in curbing speculation in the housing markets. Housing aside, we suspect that one or two more bumps of .25% each will be sufficient to remove the Fed’s accommodative rate stance given a sluggish and maybe slowing economy. Corporate earnings coming out in mid-July will likely be the next signal as to the health of the economy.