REFILE-LIVE MARKETS-Substantial oil price rise could bring Fed cuts sooner
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SUBSTANTIAL OIL PRICE RISE COULD BRING FED CUTS SOONER
While a modest, but sustained, increase in oil prices is likely to delay easing by the Federal Reserve, a substantial rise in prices would "act like an uncertainty shock" and make Federal Reserve rate cuts more likely, Morgan Stanley economists write in a note Friday.
The debate over the impact of oil prices comes as U.S. crude oil CLc1 is up more than 12% on Friday and as the U.S. monthly jobs report came in weaker than expected. Oil prices have risen sharply this week following the start of the U.S.-Israeli war against Iran over the weekend and Brent crude prices are set for their strongest weekly gain since the COVID‑19 pandemic in spring of 2020.
Expectations for a cut of at least 25 basis points from the Fed at its June meeting increased after the jobs report and were last pricing in a 51.3% chance of a cut, according to CME's FedWatch Tool, up from the roughly 30% chance earlier this week. Markets have largely ruled out any policy move by the central bank at the March or April meetings for some time.
The economists note that with inflation above Fed targets, "even modest oil prices pressures" might delay rate cuts. However, a sustained oil price shock would act like an "uncertainy shock" and weaken activity. That would bring forward rate cuts if "activity and labor markets deteriorate," the economists write.
"One scenario, a more extreme version of what we are witnessing currently, would yield similar developments to 2022 and imply oil prices above $100/bbl," they add. "Should this be sustained, we would have less confidence that activity would hold up. Our estimates suggest that if a 25% increase in oil prices via a supply shock lasts 4 quarters, doubling the price of oil, real GDP would be 1.5% lower, with a large part of the effect occurring within 3 quarters."
A large part of the effect tends to occur three to eight months after the initial shock, they note.
"In this scenario, we would expect other variables to deteriorate, including equity markets, which could trigger precautionary saving from upper income households," they write.
U.S. crude oil CLc1 is now above $91 a barrel and Brent LCOc1 is at more than $92.
In addition, the economists write, such uncertainty shocks can delay spending and hiring plans by companies and lead to layoffs.
They are also watching the reaction in the U.S. stock market to the spike in oil prices, though they note that so far the decline in U.S. equities has been limited.
(Caroline Valetkevitch)
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