What's moving the markets?
Until recently, whenever tensions in the Middle East escalated, the price of oil would rise, causing interest rates to rise as well. At the same time, the dollar would strengthen and share prices would fall. These were all understandable reactions in themselves, as rising oil prices fuelled fears of stagflation. After all, higher oil prices not only drive up inflation but also slow economic growth. The latter applies least of all to the US, as the US is largely self-sufficient in energy. This is in contrast to Europe and Japan, so it was entirely logical that the dollar would strengthen as oil prices rose.
Recently, however, tensions in the Middle East have eased considerably, causing oil prices to fall sharply. This should have led to lower interest rates, a weaker dollar and rising share prices. On balance, however, the opposite happened. How is this possible? Read more
The beginning of the answer lies in the performance of the US economy. In addition to the fact that the US economy is less sensitive to higher oil prices, it is being stimulated by expansionary fiscal policy and a boom in investment in artificial intelligence (AI). There are also doubts as to whether current interest rates are stimulating or holding back the US economy. An increasing number of economists believe the former.
The end result is that the US economy is still growing at around 2.5 per cent and, according to the latest figures, even at around 3 per cent. However, these figures relate to the period when oil prices were still very high. Since then, however, they have fallen significantly, which is giving the economy a further boost.
It should be borne in mind, however, that the price of oil remains very important to the economy, though by no means as much as it used to be. This is because the economy has been consuming relatively less and less oil. As a result, inflation is also less affected by fluctuations in the price of oil.
This is now of great importance, as the fall in oil prices is stimulating economic growth to such an extent that it is beginning to exceed potential growth. This is the combined effect of the increase in the labour force and in productivity. By definition, this means falling unemployment, but the labour market – particularly in the US – is already very tight. In other words: we must be on guard against rising wage increases. This factor carries greater weight for inflation than a fall in the price of oil.
It is true, however, that it is generally expected that AI will lead to higher productivity growth. Higher wage increases need not, therefore, be a problem for inflation. The only question is how quickly this will happen. Most economists assume that a genuine rise in productivity will not materialise for a few years. Until then, the massive wave of investment in AI will, in fact, lead to higher prices in all sorts of sectors – such as electricity and semiconductors. On balance, all the investment in AI is actually driving up inflation.
The reasoning of the financial markets
The financial markets are now reasoning as follows: The fall in oil prices, combined with fiscal stimulus and the boom in AI-related investment, is driving growth in the US above its potential.
The Fed will have to respond to this by tightening monetary policy. This prospect is pushing share prices down, flattening the yield curve, but is also pushing up all interest rates.
In Europe, this is much less the case, as growth there is unlikely to exceed potential growth any time soon.
