Recent economic data continues to suggest that the U.S. is probably near the bottom of its recession or in the very early stages of resuming economic growth. At such junctures, there can be fluctuations between growth and contraction in some sectors of the economy. At the same time, some sectors can lag when it comes to a return to sustained growth.
In the near-term, aside from Q3 GDP, for which the growth figure will likely be distorted by the “cash for clunkers” program (final demand will be a better indicator), overall growth over the next 2-4 quarters will probably remain sluggish (real annualized rate of 2% or less for most of them and for the 2009 Q2-2010 Q2 timeframe as a whole).
A “U-shaped” scenario does not represent a “new normal” to use the lingo that has proliferated in the media. Instead, it reflects the historic experience following the collapse of asset bubbles that leave a substantial debt burden in their wake. During such times, those who accumulated the sizable debt burdens tend to deleverage. With respect to the housing bubble, it was U.S. households that accumulated a historically high debt burden. Now, households are continuing to deleverage. Today’s higher than expected contraction of consumer credit is just the latest confirmation of the deleveraging trend. Such deleveraging will tend to restrain growth in real personal consumption expenditures, which still comprises roughly 70% of GDP.
Looking ahead, the labor market will likely remain a significant drag through next year, even as the unemployment rate probably peaks early next year and then begins to slowly decline. In addition, there is a structural component to the unemployment rate. Not all jobs will return. Certain sectors will likely remain notably smaller than they were in the past following the recession.
The labor participation rate, which has fallen to 65.2% of the civilian noninstitutional population could reach or drop below 65%. To put this into perspective, during the 1990-99 timeframe, the labor participation rate averaged 66.7% of the civilian noninstitutional population. At the present rate (65.2%), the labor force is 3.55 million persons smaller than it would have been at the 1990-99 labor participation rate.
An inefficient employment services sector will likely undermatch and frequently fail to match qualified employees with employers who have openings. Such a phenomenon could further slow the recovery in the job market, lengthen the duration of unemployment, and possibly contribute to some unemployed workers leaving the labor force altogether.
All those developments will likely translate into elevated consumer and real estate loan delinquencies and charge-offs and reduced growth in real personal consumption expenditures. In turn, dozens of additional bank failures are likely in coming months. A brief burst of growth in corporate profits brought about due to higher productivity/lower wage expenses could slow markedly afterward until top-line revenue growth picks up. Inflation will remain abnormally low through the rest of this year into at least part of next year. In response, the Fed will maintain its present monetary policy stance through the rest of this year and probably into at least part of next year.
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Showing posts with label economy. Show all posts
Showing posts with label economy. Show all posts
Wednesday, October 7, 2009
Wednesday, September 9, 2009
Beige Book: Continuing Economic Stabilization
Earlier today, the Federal Reserve released its Beige Book on economic conditions around the nation. The report showed continued stabilization of the overall economy with some indications of improvement. Nevertheless, numerous sectors remained weak.
A table summarizing the report follows:
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A table summarizing the report follows:
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Tuesday, August 25, 2009
IMF Research Director Outlines Challenges to Sustaining a Global Recovery
Recently, International Monetary Fund (IMF) Economic Counsellor and Director of Research Olivier Blanchard opined that a global economic recovery had commenced, but that sustaining it could require “delicate rebalancing” during which public fiscal stimulus spending is phased out and private demand replaces public demand, and during which large trade imbalances that had previously persisted moderate. In his assessment, Blanchard highlighted supply-side issues, demand-side issues, and risks associated with a failure to rebalance effectively.
A summary of those issues follows:
Supply-Side Issues:
• Partly dysfunctional financial systems in the advanced countries.
• Capital flows to developing countries that decreased may take a few years to fully recover.
• In nearly all countries, the costs of the crisis have exacerbated the fiscal burden and tax hikes may be necessary.
Demand-Side Issues:
• A return of economic growth in 2009 may not be sufficiently strong to reduce unemployment leading to a peak in the unemployment rate in 2010.
• Initial growth will depend mainly on inventory rebuilding and the fiscal stimulus, not private consumption and fixed investment spending. When the fiscal stimulus is unwound and inventory rebuilding is completed, rebalancing will be required to sustain economic growth.
Risks Associated With A Failure to Rebalance Effectively:
• An anemic U.S. recovery.
• Possible efforts to extend the fiscal stimulus. Premature phasing out of the stimulus would undermine economic growth. Extension of the stimulus could lead to concerns about U.S. debt, sparking large capital outflows from the U.S. and a potentially disorderly decline in the U.S. dollar. In turn, that additional instability or uncertainty concerning such instability could derail an economic recovery.
&&
A summary of those issues follows:
Supply-Side Issues:
• Partly dysfunctional financial systems in the advanced countries.
• Capital flows to developing countries that decreased may take a few years to fully recover.
• In nearly all countries, the costs of the crisis have exacerbated the fiscal burden and tax hikes may be necessary.
Demand-Side Issues:
• A return of economic growth in 2009 may not be sufficiently strong to reduce unemployment leading to a peak in the unemployment rate in 2010.
• Initial growth will depend mainly on inventory rebuilding and the fiscal stimulus, not private consumption and fixed investment spending. When the fiscal stimulus is unwound and inventory rebuilding is completed, rebalancing will be required to sustain economic growth.
Risks Associated With A Failure to Rebalance Effectively:
• An anemic U.S. recovery.
• Possible efforts to extend the fiscal stimulus. Premature phasing out of the stimulus would undermine economic growth. Extension of the stimulus could lead to concerns about U.S. debt, sparking large capital outflows from the U.S. and a potentially disorderly decline in the U.S. dollar. In turn, that additional instability or uncertainty concerning such instability could derail an economic recovery.
&&
Monday, August 10, 2009
FOMC’s August 12 Monetary Policy Statement: No Rate Change, but Somewhat More Upbeat
On Wednesday, August 12, the Federal Reserve’s Federal Open Market Committee (FOMC) will very likely hold the federal funds rate steady in the 0.00% to 0.25% range. Signaling continuity with current interest rate policy, Federal Reserve Chairman Ben Bernanke told the House of Representatives’ Committee on Financial Services on July 21, “The FOMC anticipates that economic conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period.”
Nevertheless, the FOMC’s forthcoming policy statement will likely reflect a combination of sentiments that are similar to recent monetary policy statements, along with some subtle changes in wording to reflect the continuing stabilization of the U.S. economy and prospects for modest growth through the rest of 2009. Overall, the statement will be somewhat more upbeat than the prior one, but it is unlikely to contain any hints of upcoming interest rate hikes or concerns about rising inflation.
Overall, one can likely expect the following in the FOMC’s forthcoming monetary policy statement:
• That the pace of economic contraction has slowed significantly and that economic activity is showing some indications of stabilizing. It may also note some enhancement in economic prospects. That wording will constitute an improvement over the FOMC’s June 24 statement in which it observed that “the pace of economic contraction is slowing.”
• That the housing market has shown additional signs of stabilizing.
• Household spending has remained fairly stable, but is constrained by continuing weakness in the labor market.
• Anticipation that “policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.”
• Modest growth in economic activity is likely during the remainder of the year.
• That inflation will remain “subdued.”
• The FOMC “will employ all available tools to promote economic recovery and to preserve price stability,” “will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets,” and that it will monitor “the size and composition of its balance sheet” and make such adjustments as might be warranted.
• Economic conditions will “likely warrant exceptionally low levels of the federal funds rate for an extended period.”
&&
Nevertheless, the FOMC’s forthcoming policy statement will likely reflect a combination of sentiments that are similar to recent monetary policy statements, along with some subtle changes in wording to reflect the continuing stabilization of the U.S. economy and prospects for modest growth through the rest of 2009. Overall, the statement will be somewhat more upbeat than the prior one, but it is unlikely to contain any hints of upcoming interest rate hikes or concerns about rising inflation.
Overall, one can likely expect the following in the FOMC’s forthcoming monetary policy statement:
• That the pace of economic contraction has slowed significantly and that economic activity is showing some indications of stabilizing. It may also note some enhancement in economic prospects. That wording will constitute an improvement over the FOMC’s June 24 statement in which it observed that “the pace of economic contraction is slowing.”
• That the housing market has shown additional signs of stabilizing.
• Household spending has remained fairly stable, but is constrained by continuing weakness in the labor market.
• Anticipation that “policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.”
• Modest growth in economic activity is likely during the remainder of the year.
• That inflation will remain “subdued.”
• The FOMC “will employ all available tools to promote economic recovery and to preserve price stability,” “will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets,” and that it will monitor “the size and composition of its balance sheet” and make such adjustments as might be warranted.
• Economic conditions will “likely warrant exceptionally low levels of the federal funds rate for an extended period.”
&&
Thursday, July 30, 2009
Fed Beige Book: Economy Possibly Near Its Bottom
The Federal Reserve’s latest Beige Book on current economic conditions by Federal Reserve district, revealed a stabilizing economy. The report noted:
Reports from the 12 Federal Reserve Districts suggest that economic activity continued to be weak going into the summer, but most Districts indicated that the pace of decline has moderated since the last report or that activity has begun to stabilize, albeit at a low level. Five Districts used the words "slow", "subdued", or "weak" to describe activity levels; Chicago and St. Louis reported that the pace of decline appeared to be moderating; and New York, Cleveland, Kansas City, and San Francisco pointed to signs of stabilization. Minneapolis said the District economy had contracted since the last report.
Overall, several themes were set forth in the report’s findings. Those themes included:
• Signs of macroeconomic stabilization are present.
• Economic activity and changes in that activity are uneven across Federal Reserve districts and by economic sector.
• No significant rebound in consumer spending is evident.
• The manufacturing sector is still sputtering.
• The residential real estate market shows signs of stabilizing in numerous districts.
• The commercial real estate sector continues to weaken.
The following table provides a brief summary of developments in the various Federal Reserve districts.
Upcoming releases of the Beige Book on September 9 and October 21 will provide evidence as to whether the current indications of stabilization led to a near-term turnaround in the economy. The latter data will also furnish additional evidence as to the strength of any near-term recovery. For now, weak consumer spending, the possible adverse impact of deteriorating commercial real estate market conditions, and historic experience following the collapse of major real estate asset bubbles hint at a rather sluggish recovery.
&&
Reports from the 12 Federal Reserve Districts suggest that economic activity continued to be weak going into the summer, but most Districts indicated that the pace of decline has moderated since the last report or that activity has begun to stabilize, albeit at a low level. Five Districts used the words "slow", "subdued", or "weak" to describe activity levels; Chicago and St. Louis reported that the pace of decline appeared to be moderating; and New York, Cleveland, Kansas City, and San Francisco pointed to signs of stabilization. Minneapolis said the District economy had contracted since the last report.
Overall, several themes were set forth in the report’s findings. Those themes included:
• Signs of macroeconomic stabilization are present.
• Economic activity and changes in that activity are uneven across Federal Reserve districts and by economic sector.
• No significant rebound in consumer spending is evident.
• The manufacturing sector is still sputtering.
• The residential real estate market shows signs of stabilizing in numerous districts.
• The commercial real estate sector continues to weaken.
The following table provides a brief summary of developments in the various Federal Reserve districts.
Upcoming releases of the Beige Book on September 9 and October 21 will provide evidence as to whether the current indications of stabilization led to a near-term turnaround in the economy. The latter data will also furnish additional evidence as to the strength of any near-term recovery. For now, weak consumer spending, the possible adverse impact of deteriorating commercial real estate market conditions, and historic experience following the collapse of major real estate asset bubbles hint at a rather sluggish recovery.
&&
Wednesday, July 29, 2009
Latest Data Indicates Housing Prices May Be Stabilizing
For the first time since July 2006, the S&P/Case-Shiller Home Price Index for 20 cities registered an increase. The data for May 2009 showed that home prices rose 0.5%. However, on a seasonally-adjusted basis, home prices continued there slide, albeit a slowing descent. The seasonally-adjusted 20-city index fell 0.2%.
The latest data may be signaling a stabilization of home prices over coming months. For March 2009, just 1 of the 20 cities saw home prices increase. In April, 4 cities experienced price gains. In May, 8 cities registered price gains. In Cleveland and Dallas, home prices rose more than 1%. Cleveland, Dallas, Denver, and Washington, DC have now experienced a rise in home prices for two consecutive months. In Denver, home prices have risen for three consecutive months.
However, some cities continued to experience precipitous declines in home prices. Las Vegas, Miami, and Phoenix all saw home prices fall more than 1%.
bor
In a potentially discouraging note for some of the hardest-hit housing markets, four of the five cities that registered the biggest price declines in May were among those that had seen peak-to-trough declines in excess of 40%. Those cities, along with their home price declines to date, are:
Las Vegas: 53.3%
Los Angeles: 41.4%
Miami: 48.3%
Phoenix: 54.3%
Among the cities benefiting from the biggest monthly home appreciation, just one (San Francisco) had seen a 40% or greater drop in home prices.
That data hints that where the asset bubble was most pronounced, not where home prices have fallen most, could see the slowest recovery in home prices. Instead, a recovery in home prices could commence soonest in regions in which the economy is most resilient and the housing bubble was less pronounced.
In the months ahead, four factors will probably play an important role in shaping any housing recovery that commences:
• Changes in long-term interest rates. The nation’s short-term fiscal situation, namely its ability to continue to finance its enormous stimulus efforts, and changes to its long-term fiscal trajectory could impact long-term rates.
• Rising unemployment. Rising unemployment could dampen consumer confidence and increase risk-aversion toward major purchases, including homes. It could also strain the finances of families with mortgages, leading to increased foreclosures and increased inventory.
• Financial system fragility that inhibits home lending, particularly if the commercial real estate sector experiences a sharpening descent. Already, 15 of the 64 bank failures this year have occurred in states in which cities saw the biggest home price declines in May. Hence, a self-reinforcing relationship between home price trends and bank failures is a possibility.
• Whether an economic recovery takes root or fizzles.
In the near-term, even as home prices are showing signs of stabilization, further declines are still likely. The epicenter of price declines will likely remain California, Arizona, Nevada, and Florida. A recent worsening of the housing situation in the Pacific Northwest may indicate continuing softness there. Afterward, even when the 20-city index bottoms out and begins to rise, regional differences in home price trends could persist for some time.
&&
The latest data may be signaling a stabilization of home prices over coming months. For March 2009, just 1 of the 20 cities saw home prices increase. In April, 4 cities experienced price gains. In May, 8 cities registered price gains. In Cleveland and Dallas, home prices rose more than 1%. Cleveland, Dallas, Denver, and Washington, DC have now experienced a rise in home prices for two consecutive months. In Denver, home prices have risen for three consecutive months.
However, some cities continued to experience precipitous declines in home prices. Las Vegas, Miami, and Phoenix all saw home prices fall more than 1%.
borIn a potentially discouraging note for some of the hardest-hit housing markets, four of the five cities that registered the biggest price declines in May were among those that had seen peak-to-trough declines in excess of 40%. Those cities, along with their home price declines to date, are:
Las Vegas: 53.3%
Los Angeles: 41.4%
Miami: 48.3%
Phoenix: 54.3%
Among the cities benefiting from the biggest monthly home appreciation, just one (San Francisco) had seen a 40% or greater drop in home prices.
That data hints that where the asset bubble was most pronounced, not where home prices have fallen most, could see the slowest recovery in home prices. Instead, a recovery in home prices could commence soonest in regions in which the economy is most resilient and the housing bubble was less pronounced.
In the months ahead, four factors will probably play an important role in shaping any housing recovery that commences:
• Changes in long-term interest rates. The nation’s short-term fiscal situation, namely its ability to continue to finance its enormous stimulus efforts, and changes to its long-term fiscal trajectory could impact long-term rates.
• Rising unemployment. Rising unemployment could dampen consumer confidence and increase risk-aversion toward major purchases, including homes. It could also strain the finances of families with mortgages, leading to increased foreclosures and increased inventory.
• Financial system fragility that inhibits home lending, particularly if the commercial real estate sector experiences a sharpening descent. Already, 15 of the 64 bank failures this year have occurred in states in which cities saw the biggest home price declines in May. Hence, a self-reinforcing relationship between home price trends and bank failures is a possibility.
• Whether an economic recovery takes root or fizzles.
In the near-term, even as home prices are showing signs of stabilization, further declines are still likely. The epicenter of price declines will likely remain California, Arizona, Nevada, and Florida. A recent worsening of the housing situation in the Pacific Northwest may indicate continuing softness there. Afterward, even when the 20-city index bottoms out and begins to rise, regional differences in home price trends could persist for some time.
&&
Friday, July 24, 2009
IMF Concludes Its Consultation with China
Earlier this week, the International Monetary Fund (IMF) announced that its Executive Board had completed its consultations with China. The IMF released a summary of the consultation. Key findings included:
• China’s robust fiscal and monetary policy stimuli facilitated an economic recovery. China’s policies have contributed to regional and global economic stability.
• Global economic challenges may make it difficult for the world’s economies to absorb China’s increased production capacity. As a result, the IMF expressed support for China’s measures aimed at boosting domestic consumption spending and reducing China’s reliance on exports.
• China’s low level of public debt should afford the country flexibility in pursuing additional targeted fiscal stimulus measures.
• The IMF called for China to closely monitor its financial system for indications of a decline in credit quality.
• The IMF welcomed China’s intent to participate in its Financial Sector Assessment Program to identify possible areas for financial system reform.
To date, the ongoing discussions in academic and regulatory circles in China concerning the possible deployment of monetary policy to mitigate the risk of an emergent real estate bubble should provide some degree of comfort when it comes to avoiding a serious deterioration in credit quality. Possible monetary tightening would tend to squeeze out marginal borrowers.
Nonetheless, given the limits of monetary policy, regulators will need to carefully watch bank lending for signs that loans are being concentrated disproportionately in any single economic sector such as real estate, down payments are being reduced significantly, or up-front inducements to encourage borrowing are being offered. Should capital inflows pick up dramatically in coming quarters, that situation would also warrant close monitoring, as such inflows could fuel a credit boom that provides access even to marginal borrowers. Those were some of the symptoms of the decay that took place in lending standards during the run-up of the recent U.S. housing bubble.
So far, China’s policy makers appear to have taken to heart a possible role for monetary policy in mitigating the rise of asset bubbles. It remains to be seen how China’s regulators will respond in seeking to preclude any material decline in credit quality, particularly as China’s economy experiences a return of robust growth.
&&
• China’s robust fiscal and monetary policy stimuli facilitated an economic recovery. China’s policies have contributed to regional and global economic stability.
• Global economic challenges may make it difficult for the world’s economies to absorb China’s increased production capacity. As a result, the IMF expressed support for China’s measures aimed at boosting domestic consumption spending and reducing China’s reliance on exports.
• China’s low level of public debt should afford the country flexibility in pursuing additional targeted fiscal stimulus measures.
• The IMF called for China to closely monitor its financial system for indications of a decline in credit quality.
• The IMF welcomed China’s intent to participate in its Financial Sector Assessment Program to identify possible areas for financial system reform.
To date, the ongoing discussions in academic and regulatory circles in China concerning the possible deployment of monetary policy to mitigate the risk of an emergent real estate bubble should provide some degree of comfort when it comes to avoiding a serious deterioration in credit quality. Possible monetary tightening would tend to squeeze out marginal borrowers.
Nonetheless, given the limits of monetary policy, regulators will need to carefully watch bank lending for signs that loans are being concentrated disproportionately in any single economic sector such as real estate, down payments are being reduced significantly, or up-front inducements to encourage borrowing are being offered. Should capital inflows pick up dramatically in coming quarters, that situation would also warrant close monitoring, as such inflows could fuel a credit boom that provides access even to marginal borrowers. Those were some of the symptoms of the decay that took place in lending standards during the run-up of the recent U.S. housing bubble.
So far, China’s policy makers appear to have taken to heart a possible role for monetary policy in mitigating the rise of asset bubbles. It remains to be seen how China’s regulators will respond in seeking to preclude any material decline in credit quality, particularly as China’s economy experiences a return of robust growth.
&&
Friday, July 17, 2009
Verleger Prediction of $20 Oil Later This Year Is Highly Unlikely To Verify
On Thursday, Bloomberg.com reported that oil market analyst Philip Verleger predicted that the price of crude oil would fall to $20 per barrel later this year. If the price of crude oil were to drop that low, it would mark the lowest price since February 7, 2002 when crude oil ended trading at $19.64 per barrel.
A closer examination of historic data and underlying fundamentals suggests that a scenario of $20 per barrel oil later this year has little chance at verifying. Although the price of crude oil reached $72.68 per barrel on June 11 before falling just over 18% to $59.52 per barrel on July 14, that recent sharp decline does not presage an imminent crash in oil prices.
• Over the past quarter-century, once the price of crude oil had risen 15% or more above the price at which it had first fallen 40% or more on a year-to-year basis, that outcome was a strong signal that the market bottom had already been reached. Since 1983, there were four occasions on which the market provided such a signal. Over the following 8 months from the date at which the price of crude oil met that recovery threshold, the price of oil remained 40% or more above the bottom that had previously been reached.
During the four previous signals, the price of crude oil ranged from as low as 132.7% of the bottom price to as high as 232.00% of the bottom price during the 8 months following the signal. The low price achieved following the signal had less fluctuation than the overall range, varying from 132.2% to 145.5% of the bottom price.
Assuming that the $33.87 per barrel price that was reached on December 19, 2008 winds up being the bottom—as is strongly suggested by the quarter-century historical experience—and the earlier historic data is representative, that would imply that the price of crude oil would range from as low as $44.93 per barrel to as high $78.58 per barrel in the May 28, 2009-January 28, 2010 timeframe. To date, the price of crude oil has closed as low as $59.52 per barrel (July 14) and as high as $72.68 per barrel (June 11) during the opening part of that period.
• Global crude oil stocks had been rising but could avert dangerous levels. Global stocks had risen 10.4 million barrels in April to levels that were 7.5% above the comparable 2008 figure. However, according to data from the U.S. Energy Information Administration’s Weekly Petroleum Status Report, U.S. crude oil stocks had increased by almost 16 million barrels during that timeframe. In other words, U.S. stocks had played a disproportionate role in leading global stocks higher. Since then, U.S. oil inventories have peaked and begun to fall. As of the four-week period ending July 10, 2009, U.S. crude oil stocks had fallen nearly 30 million barrels from their peak during the same period ended May 1.
That trend could continue until early- to mid-September. Typically, as summer driving season concludes, U.S. inventories begin to increase until heating season sets in during the late-November to early-December period.
During the 2006-2008 timeframe, U.S. oil inventories rose about 1.2 million barrels per week until heating oil season commenced. During the extreme financial market turmoil last autumn, U.S. oil consumption fell sharply and U.S. crude oil stocks rose by about 2.8 million barrels per week. That kind of increase in oil inventories that sent the price of crude oil crashing 76.7% from a high of $145.29 to $33.87 in a matter of months is not likely, as the latest macroeconomic data suggests that a number of major economies are stabilizing. A few, including China, have begun to experience more robust growth, with the Chinese economy expanding 7.9% on a year-to-year basis from a large fiscal stimulus and an extraordinary monetary policy stimulus. That latter stimulus, if it is reeled in, could touch off the development of asset bubbles. Already, the Shanghai Composite has risen 75% this year. But that development is not likely to impact China’s growth very near-term.
Stabilization of the U.S. economy and a return of growth for the U.S. economy and some major international economies over the coming months should begin to pare product inventories (gasoline, distillate fuel, etc.), as well as lead to a gradual increase in global crude oil demand. In its July 2009 report, OPEC estimates that global crude oil demand will rise from 82.80 million barrels per day in the Second Quarter to 84.84 million barrels per day in the Fourth Quarter. If that scenario begins to play out, an abnormally sharp rebound in U.S. crude oil stocks and a rise of global inventories to dangerous levels will become less likely. In other words, the kind of crippling oil glut that could cause a crash in oil prices would become unlikely.
On the supply-side, OPEC is likely to remain risk-averse through much or all of the remainder of this year. So long as U.S. consumption, which has recently flat-lined in the 18.0 million to 18.5 million barrels per day range since mid-spring, down 8%-12% from 2007- and 2008-level consumption, OPEC is likely to remain cautious about increasing production.
Moreover, considering that OPEC continues to monitor global crude oil stocks, and had even used such stocks as a yardstick in setting production quotas in the recent past when oil prices were rocketing toward their July 2007 peak, OPEC is likely to err on the side of caution in restraining its member country production. Its restraint to some recent calls for an increase in oil production after oil prices had doubled from their December 2008 low underscores OPEC’s caution.
As a result, OPEC is not likely to increase its oil production through much or all of the rest of this year, even as demand gradually increases. That production posture should help mitigate the risk of the kind of enormous oil glut necessary to bring about a fresh collapse in the price of crude oil.
In the end, if the Verleger scenario is to pan out, the world would need to witness a significant new regional or global shock that would erase the recent trend toward economic stabilization and set off another dramatic economic contraction on a global basis. While scenarios such as a collapse of Eastern Europe’s banking system could trigger such an outcome, such scenarios are not assured.
Conclusion:
Historical experience, underlying macroeconomic dynamics, and OPEC’s restraint indicate that the price of crude oil is unlikely to collapse to $20 per barrel later this year. Instead, a possible mini-bottom in the $40 per barrel to $50 per barrel range during price fluctuations is far more plausible through the remainder of this year.
&&
A closer examination of historic data and underlying fundamentals suggests that a scenario of $20 per barrel oil later this year has little chance at verifying. Although the price of crude oil reached $72.68 per barrel on June 11 before falling just over 18% to $59.52 per barrel on July 14, that recent sharp decline does not presage an imminent crash in oil prices.
• Over the past quarter-century, once the price of crude oil had risen 15% or more above the price at which it had first fallen 40% or more on a year-to-year basis, that outcome was a strong signal that the market bottom had already been reached. Since 1983, there were four occasions on which the market provided such a signal. Over the following 8 months from the date at which the price of crude oil met that recovery threshold, the price of oil remained 40% or more above the bottom that had previously been reached.
During the four previous signals, the price of crude oil ranged from as low as 132.7% of the bottom price to as high as 232.00% of the bottom price during the 8 months following the signal. The low price achieved following the signal had less fluctuation than the overall range, varying from 132.2% to 145.5% of the bottom price.
Assuming that the $33.87 per barrel price that was reached on December 19, 2008 winds up being the bottom—as is strongly suggested by the quarter-century historical experience—and the earlier historic data is representative, that would imply that the price of crude oil would range from as low as $44.93 per barrel to as high $78.58 per barrel in the May 28, 2009-January 28, 2010 timeframe. To date, the price of crude oil has closed as low as $59.52 per barrel (July 14) and as high as $72.68 per barrel (June 11) during the opening part of that period.
• Global crude oil stocks had been rising but could avert dangerous levels. Global stocks had risen 10.4 million barrels in April to levels that were 7.5% above the comparable 2008 figure. However, according to data from the U.S. Energy Information Administration’s Weekly Petroleum Status Report, U.S. crude oil stocks had increased by almost 16 million barrels during that timeframe. In other words, U.S. stocks had played a disproportionate role in leading global stocks higher. Since then, U.S. oil inventories have peaked and begun to fall. As of the four-week period ending July 10, 2009, U.S. crude oil stocks had fallen nearly 30 million barrels from their peak during the same period ended May 1.
That trend could continue until early- to mid-September. Typically, as summer driving season concludes, U.S. inventories begin to increase until heating season sets in during the late-November to early-December period.
During the 2006-2008 timeframe, U.S. oil inventories rose about 1.2 million barrels per week until heating oil season commenced. During the extreme financial market turmoil last autumn, U.S. oil consumption fell sharply and U.S. crude oil stocks rose by about 2.8 million barrels per week. That kind of increase in oil inventories that sent the price of crude oil crashing 76.7% from a high of $145.29 to $33.87 in a matter of months is not likely, as the latest macroeconomic data suggests that a number of major economies are stabilizing. A few, including China, have begun to experience more robust growth, with the Chinese economy expanding 7.9% on a year-to-year basis from a large fiscal stimulus and an extraordinary monetary policy stimulus. That latter stimulus, if it is reeled in, could touch off the development of asset bubbles. Already, the Shanghai Composite has risen 75% this year. But that development is not likely to impact China’s growth very near-term.
Stabilization of the U.S. economy and a return of growth for the U.S. economy and some major international economies over the coming months should begin to pare product inventories (gasoline, distillate fuel, etc.), as well as lead to a gradual increase in global crude oil demand. In its July 2009 report, OPEC estimates that global crude oil demand will rise from 82.80 million barrels per day in the Second Quarter to 84.84 million barrels per day in the Fourth Quarter. If that scenario begins to play out, an abnormally sharp rebound in U.S. crude oil stocks and a rise of global inventories to dangerous levels will become less likely. In other words, the kind of crippling oil glut that could cause a crash in oil prices would become unlikely.
On the supply-side, OPEC is likely to remain risk-averse through much or all of the remainder of this year. So long as U.S. consumption, which has recently flat-lined in the 18.0 million to 18.5 million barrels per day range since mid-spring, down 8%-12% from 2007- and 2008-level consumption, OPEC is likely to remain cautious about increasing production.
Moreover, considering that OPEC continues to monitor global crude oil stocks, and had even used such stocks as a yardstick in setting production quotas in the recent past when oil prices were rocketing toward their July 2007 peak, OPEC is likely to err on the side of caution in restraining its member country production. Its restraint to some recent calls for an increase in oil production after oil prices had doubled from their December 2008 low underscores OPEC’s caution.
As a result, OPEC is not likely to increase its oil production through much or all of the rest of this year, even as demand gradually increases. That production posture should help mitigate the risk of the kind of enormous oil glut necessary to bring about a fresh collapse in the price of crude oil.
In the end, if the Verleger scenario is to pan out, the world would need to witness a significant new regional or global shock that would erase the recent trend toward economic stabilization and set off another dramatic economic contraction on a global basis. While scenarios such as a collapse of Eastern Europe’s banking system could trigger such an outcome, such scenarios are not assured.
Conclusion:
Historical experience, underlying macroeconomic dynamics, and OPEC’s restraint indicate that the price of crude oil is unlikely to collapse to $20 per barrel later this year. Instead, a possible mini-bottom in the $40 per barrel to $50 per barrel range during price fluctuations is far more plausible through the remainder of this year.
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