The effects of lower oil prices are far-reaching, varied and still hotly debated.
The behaviour of capital markets over the past few months in particular suggests prices are widely seen as reflecting a persistent deficiency in global demand, rather than an ongoing gift to those more likely to consume.
Oil’s impact on inflation and, therefore, prospective interest rates is perhaps where the prevailing debate has become most muddled.
It is again a well-established empirical fact that the effects of commodity prices on both core and headline inflation tend to be transitory in nature.
The effects of last year’s declines, in particular for oil, are already in the process of washing through the figures.
Unless oil prices sink to levels materially below those seen in the market today, their impact on inflation data from here is likely to be neutral to positive over the next year or so.
Both the lagged effect on global growth and the transitory impact on inflation data are important considerations in the context of our thoughts on capital markets too.
The first effect of falling oil prices on the quoted corporate sector is negative. There are simply more companies in the stock market that suffer an immediate earnings hit from lower oil prices than those that benefit.
The picture including energy and materials is obviously worrying. Declining revenues amid cries that profit margins can go no higher are surely a justifiable cause for concern.
However, if you exclude these sectors, the growth rate looks much less alarming if still a little subdued relative to history.
Much as with equity markets, falling oil prices have a range of effects on the bond market. In the government space, the resulting subdued inflation data, though transitory, has helped yields to stay low.
Similarly, the bond market has been the most obvious beneficiary from the way in which falling oil prices have slotted so neatly into narratives around secular stagnation and persistent wider disinflation/deflation.
Parts of the corporate credit complex have suffered, particularly energy credits.
The decline in risk appetite, in part resulting from the fall in oil prices, linked in turn to fears about slowing Chinese economic growth and its ramifications, has seen spreads widen in other parts of the US high-yield complex.
Much as with the equity market, this has provided us with an interesting investment opportunity in our view.
Yields in some parts of the high-yield complex are now consistent with a level of implied defaults that look excessively conservative in the context of our expectation of improving US economic growth.
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