Seventy-dollar-a-barrel oil briefly gave the bond market fresh hope. Hope here is defined as a rationale for buying debt securities on the expectation that soaring energy costs will cripple the economy and create new momentum for a decline in the price of money. Will this twisted version of fixed-income hope prevail?
To be sure, the immediate, albeit temporary trigger in today’s oil-price spike had little to do with economics per se. Rather, the culprit was weather: Hurricane Katrina wreaked havoc in the Gulf of Mexico, which is a critical region in the domestic production of oil in the U.S. To be sure, the clean-up tag for Katrina promises to be substantial, which ultimately will be an economic issue. But for today, at least, oil traders were more interested in meteorology than gross domestic product.
But no matter the catalyst, all energy roads ultimately cross the path of the dismal science proper, and not necessarily for the good. “We can expect two months of lost [oil] production, and coming in the peak demand period this is the worst possible news,” David Thurtell, strategist at the Commonwealth Bank of Australia, told Reuters today. In other words, even higher prices could be coming.
Oil traders predicted as much and bid up the near-term futures contract for crude to nearly $71 a barrel at one point on Monday before the price fell back to around $67. Things were just as volatile and uncertain in the natural gas markets. The New York Mercantile Exchange went so far as to declare force majeure on deliveries tied to the August futures contract. Translated: producers could avoid penalties even though they don’t deliver the underlying commodity to buyers.
Surprisingly, the stock market didn’t seem to mind any of this. The S&P 500 rose by 0.6% on the day. The bond market was less enthused but the yield on the 10-year Treasury managed to slip a bit on the day, falling to 4.17%, near the lowest in about a month.
The bigger question that Katrina triggered anew is whether oil’s climb will come back to bite the primary engine in the economy, namely, the consumer. Barry Ritholtz, market strategist at Maxim Group, thinks it will, in part because Joe Sixpack’s spending spree was already looking a bit long in the tooth. Writing today on his blog, The Big Picture, he laid out what he thinks awaits: “While it is premature to declare the American consumer shopped out,’ I suspect it is now quite late in the cycle. Barring a significant improvement in economic fortunes, including robust job creation and increased personal income levels, that exhaustion now looks all but inevitable.”
If so, the bull market in energy threatens to become a straw, if not the straw that helps breaks the economy’s back. If so, what’s a central bank to do? The Federal Reserve has in fact been raising the price of money in an attempt to slow the speculative forces in the real estate market and also nip any burgeoning inflationary forces, born of the easy money policy that ran rampant in past years, in the bud. But if an energy-induced crunch is coming, the Fed’s current policy of raising interest rates could turn out to be the 20th century heir to the misguided policy of tightening in the early 1930s, as an economic slowdown gathered steam.
But there are no easy central bank answers, and by extension nothing that resembles an obvious trade in the fixed-income world. Indeed, we’re also told that the ascent in the price of fuel has largely been a byproduct of a bubbling global economy.
Which view of the universe will sway the Fed? Perhaps Greenspan, in his waning days as Fed Chairman, will split the difference and hold pat on future rate increases while keeping the previous 10 hikes intact. Much will depend on fresh economic data, which starts with tomorrow’s factory orders for August, followed by a fresh update on second-quarter GDP scheduled for release on Wednesday.
There are already a fair number of economic signals both in support of monetary tightening and for the opposite. Ours is a moment in time that looks to be a tipping point. One sign is the rising volatility in the stock market this month, as depicted by the VIX Index. Figuring out if the tip comes, and what will trigger it, and the degree of the kickback is the trick.