It seems as if the Fed’s increase in interest rates is almost as anticipated as the new Star Wars film (well, on Wall Street at least), and the likely impact on different markets is hotly debated. Opinions seem to range from the insignificance of a butterfly wing flapping to a hurricane caused by the flapping of a butterfly wing. With all the factors driving oil prices of late, this seems to be the second biggest one in December. (Not after the Star Wars opening, but the Venezuelan elections on December 6th.)
(Science note: the number of butterfly wing flaps in the Amazon rainforest in a given year is probably in the trillions, and the annual number of hurricanes doesn’t make three digits, so the metaphor of a butterfly upsetting a chaotic system to cause a hurricane is grossly overblown.)
The importance of the Fed’s Quantitative Easing (QE) policy on oil prices has been much discussed, and is sometimes blamed for at least part of the elevated levels seen in the past decade. For one thing, returns on bonds being abysmally low, investors have sought alternative places to put their money, and commodities was one of them, reinforced by gains due to the “supercycle” which predates QE.
Another explanation is that economic instability coincident with (and causing) QE made oil a “strategic” commodity, rather like gold, having a value that was beyond its industrial usage. For security in uncertain times, buy gold and oil became the new mantra. Personally, I am unpersuaded that this explanation holds more than a small amount of water; the “security” premium resulting from political instability in oil exporting nations seems much more salient than the use of oil as a “safe haven” investment.
QE being inversely correlated with economic strength, it would seem as if more QE would lower oil prices, since it implies weaker economic growth and thus lower oil demand. The end of QE would suggest stronger economic growth and higher oil demand, which would remove one of the major bearish factors driving oil prices lower this year.
Which begs the question: is the Fed a leading or lagging indicator? In this case, it would seem to be a lagging indicator, with the experience of 2008 making it very gun shy about not offering enough stimulus. This means that the Fed rise is nothing more than confirming what the market already knows, namely that the US economy is in good but not great shape and any improvement in oil demand in this country will probably be anemic. So a rate rise won’t boost oil prices due to an expected change in the demand trend.
But neither is a flight from oil as an asset to bonds likely, in my opinion. After the drop from $110 to $40 (WTI) in the past year, few investors are going to see it as a safe haven. (Gold is down about a third, by comparison.) In essence, the flight from oil has already flown.
In sum, the Fed rate rise will unleash countervailing forces on the price of oil, but almost certainly so minor as to be overwhelmed by market conditions (record high global oil inventories) and geopolitical instability (Venezuelan elections).
