Correlation Grows Between Financial Markets, Oil Prices

Dean Foreman
Posted November 15, 2018

Earlier this year we pointed out that a roller coaster of emerging economic factors could affect oil markets and, ultimately, consumers – and we were correct.

Rising interest rates, trade and tariff disputes, near decade-high U.S. dollar appreciation and potential financial market uncertainties have become pronounced over the past few months, affecting global crude oil markets and producing the strongest correlation between financial markets and oil prices in years.

One tangible result of this is the increase in borrowing costs for businesses and consumers. High-yield bond rates (those rated below investment grade), rose to 11.25 percent as of Nov. 13 from below 10 percent at the beginning of the month. Federal Reserve data show consumer credit card interest rates also have risen and are now above 14 percent. One could impact the way businesses invest, and the other could affect consumer spending.

Looking to the fourth quarter (Q4), let’s look at potential impacts on energy markets that should be monitored.

Since economic growth drives and energy demand growth, a fundamental point is that the Bloomberg consensus expects GDP growth in the U.S. and globally to slow over the next two years. Signs of this already are evident now in Europe (subscription required) and China. China is taking actions to stabilize its economy and recently depreciated its currency to the weakest level versus the U.S. dollar in a decade.

Here at home, U.S. economic growth has been solid. However, recent growth also has been boosted by accelerated home building and sales in advance of interest rates that have risen as well as goods shipping and inventory stocking in advance of escalating trade disputes that could endure. Even with this boost, however, GDP growth in Q3 just reached the administration’s objective of 3 percent real GDP growth (on an annualized basis) compared with the same quarter last year. Looking a year ahead, the Bloomberg consensus expects the pace of growth to weaken to 2.3 percent in Q4 2019. This is important because, despite a strong economy, the U.S. government has borrowed $1.3 trillion in 2018. Taking on debt of this magnitude when the economy has been strong suggests the United States’ path forward could be difficult to sustain.

Critically, emerging market economies have quietly fallen, one by one. You may know about the recent crises in Turkey and Argentina. Argentina just received the International Monetary Fund’s (IMF) largest bailout loan ever of more than $50 billion. Brazil and Russia are struggling with currency depreciation. The IMF is now assisting or bailing out Pakistan, Ghana and San Marino. South Africa may come next, which would make India the only of the BRICS countries (Brazil, Russia, India, China and South Africa) remaining in good shape.

Global economic and energy demand growth depend critically on investment and trade. None of this can happen without credit, so it is important to monitor how the weakening among emerging markets has stressed global financial markets. The Bank of International Settlements (BIS) recently quantified that 2018 financial market reverberations have decreased equity prices and global exchange rates in relation to the U.S. dollar at the same time as they increased bond yields. 

They highlight the symptoms this year already have been comparable to episodes in 2013 and 2015. In 2013, it was the “Taper Tantrum” surge in U.S. Treasury yields that resulted from the Federal Reserve's use of tapering to reduce liquidity it was pumping into the economy. In 2015, “China’s jitters” or growth concerns suddenly put on hold international lending to Emerging Markets, but the flow of credit soon resumed. However, this year has been different so far. The BIS shows international debt issuances to emerging markets declined over the past year and have not shown signs of a rebound, which ultimately could become the difference between global growth that is resilient or a recession.

As global economic growth goes, so generally do oil markets. The sensitivity of oil demand growth to economic growth has weakened slightly since 2015. Oil prices have risen for each of the past two years, but global oil demand has grown at roughly half the rate of global GDP growth on a market exchange rate basis. The role of the global financial markets in supporting the real economy is an important signpost to watch for in assessing the health of the global oil market.