BIL: Faster Fed tightening unintended consequences of oil price drop

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Yves Kuhn, chief investment officer at Banque Internationale à Luxembourg (BIL), comments on the unintended consequences of oil price movements

The oil price collapse is setting records across financial markets: with crude, the petro-currencies and high-yield credit spreads posting moves not seen outside of US or Asian recessions over the past 30 years.

Winners and losers: quickening wage pressure and faster tightening from the Fed

The dramatic fall in energy prices could jump-start economic activities on a global scale. Wage pressures would emerge faster in the US than expected, the Fed would probably tighten rates sooner, and rates on long-term treasuries would increase, causing severe volatility in a traditional ‘safe haven’ asset class.

On the flipside, the oil-producing countries will have less income, and energy companies might start cutting back on capital expenditure. Junk bonds in the US might suffer, as nearly 20% of the high-yield index consists of energy companies. Russia is on its knees, as a big part of its economy is closely linked to fossil energy.

Growth worries

The biggest downside risk is a further deterioration of growth outside of the US, or growth deterioration within the US. As a consequence, the Fed would be unlikely to raise rates in 2015. Unemployment would rise massively worldwide, and wealth destruction could be substantial.

A perfect storm for Europe

In the very short term, the drop in oil price is deflationary, but in the mid- to long-term, will clearly be inflationary, as consumers will have more money to spend and companies will have a windfall in earnings through lower energy costs.

Europe could not hope for anything better. The weakening euro and the drop in energy prices should jump-start the European economies and with full-blown quantitative easing now in place, we may see economic growth which could be north of 1.5% for 2015.

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