The escalating conflicting in Iraq has global investors worried that oil prices will continue to rise into the summer travel season. Will rising oil prices delay the Fed, or worse, impact growth for the remainder of 2014?
Tensions In Iraq
Oil prices have started to rise aggressively since militants led by ISIS – the Islamic State in Iraq and the Levant – captured key cities including Mosul and Tikrit last week.
Reports from the UN of “major human rights violations” has many worrying that this is the start of another long term conflict.
Headlines “predicting” the future rise of oil prices are already starting to pop up:
Impact on Yields and GDP
The big question is will this rise in oil prices delay further tapering by the Fed?
Short term interest rates are already reacting to rising oil prices. One year US treasury yields continue to drop as oil prices rise:
Studies have shown that a quick rise in oil prices, unrelated to economic growth/demand, do impact the economy”
When observing higher oil prices, most of us are likely to think about the price of gasoline as well, since gasoline purchases are necessary for most households. When gasoline prices increase, a larger share of households’ budgets is likely to be spent on it, which leaves less to spend on other goods and services. The same goes for businesses whose goods must be shipped from place to place or that use fuel as a major input (such as the airline industry). Higher oil prices tend to make production more expensive for businesses, just as they make it more expensive for households to do the things they normally do.
Oil price increases can also stifle the growth of the economy through their effect on the supply and demand for goods other than oil. Increases in oil prices can depress the supply of other goods because they increase the costs of producing them.
Additionally rising oil prices have shown to negatively impact GDP growth:
IMF Cuts US Growth Outlook
The IMF now sees the US economy growing 2 percent this year, down from an April estimate of 2.8 percent. The IMF left their 2015 prediction unchanged at 3 percent, and said it doesn’t expect the U.S. to see full employment until the end of 2017, amid low inflation.
The IMF went on to say that the Fed may have to keep interest rates at zero for longer than investors are expecting.
The Federal Open Market Committee (FOMC) will meet this week and I am hoping they will address the rise in oil prices in their outlook.
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