• 1 day Are Energy Stocks A Good Bet?
  • 2 days Investors Apprehension Makes $3,000 Gold Seem Feasible
  • 3 days Beijing Just Turned Up The Heat In The Tech War
  • 4 days How Big A Threat Is Climate Change To The Global Economy?
  • 5 days $120,000 Banana Gets Eaten At Art Basel
  • 6 days The Fastest Growing Energy Sectors Of 2019
  • 7 days How To Spy On Yourself: The Doorbell To End Civil Liberties
  • 8 days Analyst Predicts Tesla Stock Will Soar To $500
  • 9 days Australian Billionaire To Invest In $88 Million Struggling Solar Project
  • 10 days Twitter-Shaming: The Biggest Threat To Any Business
  • 10 days Canada Looks To Become A Major Source For Critical Minerals
  • 10 days Hedge Funds Are Piling Into This Key Commodity
  • 12 days Trade Deal Not Likely Before Christmas 2020
  • 12 days America's $16 Trillion Debt Bubble Is About To Burst
  • 13 days Black Friday Breaks Online Shopping Records
  • 13 days Tesla's Biggest Competitor Is Hiding In Plain Sight
  • 14 days Are Celebrities Good Or Bad For Cannabis Stocks?
  • 15 days Venezuela’s Crisis Continues As Maduro Spends $5 Billion On Oil Deals
  • 16 days Elon Musk Claims 250,000 Orders For Cybertruck
  • 17 days How To Survive Thanksgiving Politics With Cannabis Gravy
Zombie Foreclosures On The Rise In The U.S.

Zombie Foreclosures On The Rise In The U.S.

During the quarter there were…

Another Retail Giant Bites The Dust

Another Retail Giant Bites The Dust

Forever 21 filed for Chapter…

Is The Bull Market On Its Last Legs?

Is The Bull Market On Its Last Legs?

This aging bull market may…

  1. Home
  2. Markets
  3. Other

Interest Rates and Oil

Here is an extract from commentary posted at www.speculative-investor.com on30th November 2003:

We expect the Fed to hike short-term interest rates aggressively during 2004; not as part of a well thought-out plan or because Fed Chairman Alan Greenspan is not politically astute (he is most definitely a political animal), but rather because the bond market will force the Fed's hand. In a nut-shell, we think the Fed governors mean what they say when they talk about leaving the Fed Funds Rate near its current low levels for the foreseeable future and we are well aware that the Fed will not want to hike rates during the months leading up to the November-2004 Presidential election. However, once long-term interest rates begin to move sharply higher in response to growing inflation fears the Fed will have no choice other than to hike short-term rates with some urgency in order to rein-in the inflation fears. Not to do so, in such a situation, would invite a collapse in the value of the dollar and all dollar-denominated debt.

In other words, our forecast of a substantially higher Fed Funds Rate by this time next year is inextricably linked to our forecast of a large decline in bond prices (a large rise in long-term interest rates) over the next 6-12 months. In the absence of a large fall in long-term bond prices, though, the Fed will have the freedom to do whatever it wants with short-term rates. And Fed representatives have made it crystal clear that what they want is for short-term rates to remain near multi-decade lows over the coming year.

The upshot of the above is that if something happens to prevent long-term US interest rates from rising then the Fed will almost certainly NOT hike short-term rates. The question is; what could prevent long-term rates from rising or even cause them to fall?

As discussed in previous commentaries, the Fed could not prevent long-term rates from rising by directly intervening in the market (for example, by buying bonds). Such an action on the part of the Fed in an environment in which inflation fears were already rising would be counter-productive because it would heighten the inflation fears.

In fact, the only forces that would appear to be capable of holding-down long-term US interest rates are forces over which the Fed has no direct control.

Foreign central bank buying of US bonds is probably the most obvious and also the most benign (from a short-term US perspective) of these forces. In their efforts to prevent their currencies from appreciating against the US$ some foreign central banks have made enormous purchases of US bonds over the past year, thus helping to perpetuate the 'low-inflation illusion' and the low interest rate environment in the US. However, while it is reasonable to assume that foreign central banks will continue to provide significant support to US bond prices during periods of US$ weakness it is doubtful that they could stem the tide in an environment in which inflation fears were rising at a rapid rate. In particular, the buying of US bonds by foreign central banks would likely be insufficient to prevent long-term US interest rates from rising if private investors, as a group, began to reduce their exposure to dollar-denominated debt (over the past year non-US private investors have continued to increase their combined exposure to US debt securities, albeit at a slower rate than in previous years).

So, foreign central banks are likely to play a part in supporting US bond prices over the coming year but in isolation we don't think they represent a major threat to our forecast for a substantial rise in US interest rates.

We think the biggest risk to our current interest rate forecast revolves around the relationship between oil and bonds discussed in our 24th November commentary. Just to recap; in the aforementioned commentary we showed, with the help of the below chart, that the US T-Bond price has followed the oil price with remarkable consistency over the past 2 years, a relationship that makes some sense if we assume that the oil price has been driven primarily by geopolitics over this period. This suggests that an upheaval somewhere in the world that threatens to disrupt the oil supply has the potential to cause capital to come flooding into US Government debt.

As well as giving a substantial boost to US bond prices an oil-supply shock would prompt a sharp sell-off in the US stock market and in non-energy commodities. Therefore, even if such a supply shock turned out to be short-lived it would effectively remove any pressure on the Fed to hike short-term interest rates. In other words, in such an environment Greenspan and Co. would be able to follow-through on their promise to leave the Fed Funds Rate at multi-decade lows for the next year, although we doubt that an oil-related crisis is something that is currently at the forefront of their minds.

By the way, an oil crisis would not necessarily originate in the Middle East. For example, a substantial portion of the oil imported by the US comes from Venezuela, so a problem in Venezuela could turn out to be the catalyst for such a crisis.

At this stage our forecast is for the oil price to experience a normal bull-market correction to the low-20s over the next several months so we are obviously not anticipating an oil crisis. However, we don't know what is going to happen in the future and if the situation starts to evolve in a way that does not mesh with our expectations then it will be important to revise our expectations. After all, we don't make forecasts for the sake of making forecasts. Our goal is to make money and any forecasts we make along the way are just roadmaps that are always subject to change as the facts change and/or as more evidence becomes available.

Below is a weekly chart of oil futures. A weekly close above $32.50 in the nearest futures contract would warn us that an oil crisis might be brewing and prompt us to re-assess our interest rate forecasts.

Back to homepage

Leave a comment

Leave a comment