Oil and Interest Rates

Oil and Interest Rates

Has the American consumer been partying or what? It seems like it was just yesterday that Americans were paying $4.70 for a gallon of gas. People were trading in their Excursions for Priuses, and their full-sized Tundras for monthly passes on the Metro. Well, the advent of the hydraulic fracking of Bakken shale has yielded an oversupply of oil unseen since the 90s and consumers are lovin’ it. People are filling up the tanks of their Navigators and spending the savings on dinners, movies, bags and boots. With prices down from $4.70 to $2.35, the 50% price reduction has shifted disposable income into other goods and services and also savings accounts. But what about oil’s effect on interest rates? In many ways you would be surprised.

First of all, as oil prices fall, the dollar rises. This makes American produced items more expensive to the outside world. Oil, or to use a more general term, energy is a major component in the calculation in the rate of growth within our economy. at times it can account for 9% of total GDP. The Fed would like nothing more than for the economy to grow at a rate of 2-3%, however, with such a drastic reduction in the price of oil, the Commerce Department feels that inflation may not exceed 1.5%. Accordingly, the Fed may choose not to raise interest rates as broadly expected by the American people and predicted by economists around the globe. If rates don’t rise and inflation doesn’t catch hold, we are due for more stagnation, as prices of goods aren’t going up, but neither are workers’ wages.

For the consumer, the short term has been great. Not only are fuel costs down, but also the 10-year Treasury is down to almost 2.00%. This has translated into residential rates falling back into the 3.5% range. Commercial loans on apartments hover in the high 3s, and traditional loans on office and retail are solidly in the low to mid 4s. So for those who felt that the party is over, think again. Historically low mortgage rates are still available and present, but in the broad scheme things, oil’s decline is of great concern to the macro economy.

Because oil prices are falling, prices of all types of goods are falling. If prices of goods are falling, manufacturers are not raising the prices of the goods they produce. So if manufacturers don’t raise their prices, wages remain flat, or they fall! When wages stay flat or fall, it creates doubt and pessimism. In spite of the record low oil prices and low interest rates, the lack of inflation, and corresponding increases in interest rates, leaves the country in economic and emotional doldrums. This leaks into society and turns into reduced desires to buy homes, apartment buildings and other structures. People sit on the sidelines and worry. This new phenomenon is exacerbated by the fact that Venezuelans are pilfering grocery stores, Russians are selling rubles by the garbage bag and Brazilians are standing in mile long unemployment lines due to costs of having a society that is primarily reliant on oil. So the cheaper the oil is, the less money these countries have, and the more their citizens suffer.

In our own bubble of living life from day to day, low oil prices and low mortgage rates are absolutely great. Unfortunately, in the macro analysis, lower oil prices and lower rates translate into lower faith and confidence in our economies as a whole.

So oil is driving people back to the pump and away from the bus stop, but it is also driving a lot of the world into ruin. The basic rule of thumb still stands, when the economies of the world are celebrating, rates go up. When the economies of the world are in ruin, rates go down. Domestically, our low cost oil and amazingly low rates are a boon. However on a global scale, they’re a bust.

Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance; he can be reached at howardpr@rosecityrealtyinc.flywheelsites.com.