Results 1 to 6 of 6

Thread: Vanguard Insights: Oil and the economy: What's the tipping point?

  1. #1
    Join Date
    Aug 2009
    Location
    Somewhere in time and space
    Posts
    3,158

    Default Vanguard Insights: Oil and the economy: What's the tipping point?

    Oil and the economy: What's the tipping point?
    Link
    APRIL 19, 2011

    Amid continuing unrest in oil-producing regions, the price of crude oil has surged in recent weeks—and with it, the price of gas we pay at the pump. That's led consumers and policymakers alike to worry about consequences for the fledgling U.S. economic recovery.

    Although oil prices in the United States have yet to approach their July 2008 highs of over $145 per barrel, energy-market analysts expect oil to remain at or slightly above $100 for the foreseeable future. However, prices could push markedly higher because of further political unrest in the Middle East, supply disruptions in other parts of the world, or increased demand resulting from stronger-than-expected global growth.

    "While we remain cautiously optimistic about the U.S. economic outlook, rising oil prices are arguably the greatest risk to the economy," said Joe Davis, head of Vanguard Investment Strategy Group and coauthor of a newly published research paper on the topic.

    A 1970s rerun?
    Some investors may be concerned about a repeat of the 1970s and early 1980s, when sharp supply-driven spikes in oil prices coincided with an equity bear market. This sparked higher inflation and government bond yields, and contributed to rising unemployment. Given that track record, many wonder at what point higher oil prices could derail the current recovery, and what that might mean for inflation and short-term interest rates.

    Because oil prices are notoriously difficult to predict—and thus are a wild card in any economic or investment outlook—Mr. Davis and coauthor Roger Aliaga-Díaz analyzed several hypothetical oil-price scenarios through 2013 to assess oil's potential impact on economic growth, inflation, and Federal Reserve policy.

    Looking at the scenarios
    Based on Vanguard's analysis, the charts below illustrate how various oil-price scenarios might affect U.S. gross domestic product (GDP) and the unemployment rate through the end of 2013.

    For both charts, the black line indicates actual figures for 2010 and the first quarter of 2011, followed by estimates based on consensus expectations through the end of 2013, for West Texas Intermediate (WTI) crude oil, a commonly used benchmark. The other lines show how GDP and unemployment might fare under five hypothetical price-per-barrel scenarios.


    Sources: Vanguard calculations, based on data from the New York Mercantile Exchange (NYMEX), Federal Reserve Bank of Philadelphia, Bloomberg, U.S. Energy Information Administration, U.S. Bureau of Labor Statistics, U.S. Census Bureau, and U.S. Federal Reserve.

    "Our calculations suggest that crude oil prices would likely need to persist at $150 per barrel to generate a U.S. recession, although even $120 per barrel would likely engender a weaker-than-expected recovery, or 'soft patch,' later this year," Mr. Davis said.

    With the WTI benchmark hovering close to $110 in mid-April, he added, there is only a small margin of error for the economy and the financial markets.

    The inflation outlook
    While Vanguard's analysis found that an uptick in inflation is more likely than not over the next two to three years, Mr. Davis believes 1970s-style inflation for non-energy consumer products is unlikely.

    "Core inflation appears to have bottomed out from extremely low levels, and it tended to rise in every oil-price scenario we considered," he said. "However, core inflation above 3% would be difficult to generate in today's economy unless oil rises above $150 per barrel."

    Subdued wage pressures and moderate money-supply and credit growth in the U.S. economy should also help keep inflation in check, Mr. Davis added.

    "The oil-price shocks of the 1970s and early 1980s helped fuel broad-based and sustained high inflation rates in large part because wages were expanding rapidly before the oil shocks hit—at an annual rate of over 8%, compared with a much more modest 2% rate today," he said.

    Implications for the Fed
    Given the Federal Reserve's dual mandate for price stability and full employment, how might Fed policymakers react if a continued rise in oil prices dampens U.S. economic growth and inflation edges upward?

    For more than a year, the Fed's target short-term lending rate has persisted at virtually zero, and economists have long expected the nation's central bankers to begin ratcheting it up. Vanguard's analysis also points to a slow but steady rise in interest rates, based in part on a widely-used statistical framework that calculates an "optimal" rate based on various assumptions, including consensus expectations for unemployment and inflation.

    "While it's always difficult to assess the future direction of interest rates, our calculations indicate that the near-0% rate may no longer be optimal, regardless of the direction of oil prices," Mr. Davis said. "We cautiously interpret our simulations as consistent with an increased bias toward rising short-term interest rates, albeit at a pace that may leave the Fed's target rate below its historical average for an extended period."

    However, Mr. Davis emphasized that a rising federal funds rate won't necessarily lead to negative returns for bond investors, since under certain circumstances higher interest rates could reinforce the market's long-term inflation expectations—the key driver of long-term interest rates.

    What should investors do?
    In March, shortly after the current wave of Mideast unrest began, Martin J. Riehl, CFP®, of Vanguard Asset Management Services™ cautioned against making major investment moves based on possible shifts in oil prices, inflation, or interest rates.

    "Basing any investment decision solely on breaking news headlines is generally a bad idea," he said. "Energy is a notoriously volatile sector, and there's plenty of precedent for a sudden run-up in prices being followed by an equally sudden pullback."

    The best approach, Mr. Riehl said, may be to rely on time-tested principles of balance and diversification.

    "Investors don't like to be told to 'wait and see,' of course, but caution is often the best strategy during uncertain times," he said. "Our experience has shown that a portfolio that's broadly diversified across sectors and asset classes can be better positioned to ride out periods of tumult and volatility. We advise clients to consider paying close attention to their asset allocation and take appropriate steps to make sure their portfolios are properly aligned with their risk tolerance and long-term financial goals."
    "I never should have made it, but I'm still alive" — "Dead End Streets", RevCo

  2. #2
    Join Date
    Nov 2010
    Posts
    3,631

    Default

    The TV news today was talking about $6 gas.....

    They are lubing us up for the insertion....

    We felt the effects of $4 gas and everyone still had a job...

    We will definately feel the effects of $5-6 gas with nobody working...Say goodbye to the good old days....and hello to the bread lines....

  3. #3
    Join Date
    Aug 2009
    Location
    Somewhere in time and space
    Posts
    3,158

    Default

    I don't doubt that the price is going to go up at the pump. Potentially up considerably. That wasn't, really, the topic of this investing article though.
    "I never should have made it, but I'm still alive" — "Dead End Streets", RevCo

  4. #4
    Join Date
    Feb 2010
    Location
    Northwest NJ
    Posts
    716

    Default

    Quote Originally Posted by Rivet View Post
    I don't doubt that the price is going to go up at the pump. Potentially up considerably. That wasn't, really, the topic of this investing article though.
    What was the topic then? Good times all around? A couple of idiots talking out their asses? Invest in Wall Street is the theme I got from it.

  5. #5
    Join Date
    Aug 2009
    Location
    Somewhere in time and space
    Posts
    3,158

    Default

    Quote Originally Posted by opsview View Post
    A couple of idiots talking out their asses?
    The piece was authored by Joseph H. Davis, Ph.D (macroeconomics and finance at Duke University) who is the Vanguard's chief economist. The study referenced in the article was co-written by Davis and Roger Aliaga-Díaz, Ph.D.

    Yep, no credentials there.
    Last edited by Rivet; 04-23-2011 at 10:57 PM.
    "I never should have made it, but I'm still alive" — "Dead End Streets", RevCo

  6. #6
    Join Date
    Oct 2009
    Location
    Texas
    Posts
    3,645

    Default

    I'm not sure what the jest of the article may be to you Rivet, but what I will say, is that if we as investors are investing in oil futures we are actually hurting ourselves in the long run.
    "The Constitution is not an instrument for the government to restrain the people, it is an instrument for the people to restrain the government - lest it come to dominate our lives and interests." Patrick Henry

    Any Man Who thinks He Can Be Prosperous By Letting The Government Take Care Of Him, Better Take A Closer Look At The American Indian


Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •