Monetary policies continued to have an important influence on the global economy and recent efforts by OPEC and some non OPEC producers to re-balance the oil market, may turn out to be supportive for a normalization of monetary policies by major central banks.
Rising cooperation leading to a faster re-balancing of the oil market in the energy sector, is leading to a healthier inflation levels in major economies and to improvements in global economic growth.
Although uncertainties remain, recent oil market related developments in combination with further improvement in the OECD economies and expected recovery in Russia and Brazil in 2017 and continued high growth levels in China and India, may put central banks in a better positions to gradually reduce the extraordinary monetary stimulus, that has been a key factor for the global economic recovery since the great recession in 2008 and 2009.
While the US Federal Reserve had been tightening monetary supplies since 2015, the European central bank and other central banks are likely to continue their monetary stimulus in the short term.
In the near term, the FED is looking to raise interest rates further, following the improvement of the US economy, healthier labor market together with rising inflation of close to two percent. The FED expects that the evolution of the economy will warrant only gradual increases. However, the fiscal stimulus plans of the new administration may trigger a more rapid rise in interest rates than currently anticipated. This would particularly be the case if the major part of the stimulus is financed by an increase in government debt.
Therefore, there is some uncertainty about the pace of future interest rate increases. Given the importance of the U.S. economy, and the status of the US dollar in global trade, how the oil market is affected by such developments, depend on whether the issues are considered from the short or medium term perspective.
There are numerous short term impacts of US monetary policies on oil markets. Rising U.S. interest rates could result in increased capital outflows from emerging and some other economies enhance lower economic activity especially in emerging countries, limiting oil demand growth. Such capital outflows are usually accompanied by increase speculative activities, potentially impacting oil price volatility significantly in the short term.
Additionally, the expectation of higher yielding US dollar denominated investments may support the strengthening of the dollar versus major currency counterparts, which usually weighs on oil prices.
At the same time, an increase in US Dollar interest rates negatively affects oil industry investments by making them costlier, especially expansive and highly leveraged oil developments.
This also raises the cost for oil carry inventories, although the impact on stock level will depend on the shape of the futures curve. At the end of the December 2016, the futures curve for both NYMEX’s WTi and ICE Brent was already showing the first sign of backwardation.
While the ECB and the Bank of Japan have continued with their extraordinary monetary policies, including ultra-low or negative interest rates, a shift towards normalization is possible. With inflation in these economies rising significantly from last year’s levels, to now standard 1.1 percent in the Euro zone and 0.5 percent in Japan, some reduction in monetary stimulus is foreseen. However their policies are likely to remain more accommodative than the FED’s.
A continued normalization of monetary policies indicating improving economic conditions together with the recent historic cooperation between OPEC and non-OPEC producers should help to bring needed stability to the oil market, hence further supporting world economy.