The classic economic interpretation of a drop in Oil prices is that it’s a boost to GDP. This is true enough, but it is also a dampener to inflation.
With Oil indicating expected demand, the positive growth effect can be diminished by less consumption. This environment can certainly have a negative effect on producing nations and companies. Financial Times article weighs growth, deflation and tail risk, e.g., collapse of the Russian economy, banking crisis due to defaults. We still contend the big issue is timing:
- How long does it takes for consumers to spend their “Oil price decline” windfall?
- How fast do companies shed jobs in the Oil sector?
- How badly do companies avoid expansion because of the slowdown implied in the lower Oil price?
- How quickly do lenders have collection problems with energy loans?
We hold that the near term effect on rates is bullish (lower rates) and the long term effect is bearish (higher rates).