Oil Implications And Fed Policy

Tyler Durden's picture

Oil is battling hard with Greece to top the tail-risk-du-jour in financial markets recently. As Credit Suisse notes, the US economy so far seems to have shrugged it off as 'gasoline-sensitive' economic data for Feb have ignored the price rise for now. The extreme (warm) weather may be shielding the economy from the effect of these higher energy costs, as are consumers habituation with relatively high prices, and while CS remains more sanguine than us on energy's negative impulse they set forth some useful implications (rules-of-thumb) for what oil means for gas prices, headline inflation, real disposable income, and GDP growth pointing to $150 Brent as a critical threshold for the economy (or equivalently $4.50 retail gasoline prices). Of course, Fed policy precedents and implications are necessarily situational as the hope for this being a 'temporary' situation but the circular reaction to the consequences of any growth drag will merely exacerbate the situation. Was Bernanke's recent less unconditional dovishness an implicit effort to 'tighten' expectations and manage the war-premium out of oil prices?

Rules of thumb

There are “rules of thumb” we can apply for inflation, gasoline spending, and real income that are helpful for analytical purposes, although the actual impact on the economy is more

  • For every $1 rise in the price of oil, gasoline prices rise by about 2.5 cents at the pump.
  • Every penny rise at the gasoline pump adds slightly more than $1bn to the household sector gasoline bill (assuming no alteration in driving behavior).
  • Every $10 increase in the price of crude oil raises headline CPI inflation by 0.3-0.4 ppt.
  • Every $10 increase in the price of crude oil reduces real income growth by 0.3-0.4 ppt.
  • And for the impact of oil price shocks on GDP growth...


In our central scenario, our simulation suggests that real GDP growth would emerge relatively unscathed, with GDP predicted at 2.5% annualized by Q4. This result comes very close to the current consensus estimate (2.6% based on February Blue Chip) and our own forecast (2.3%).

The “high” scenario assumes a somewhat faster oil price increase and predicts slightly slower growth. Our simulation suggests that real GDP growth would slow down to 1.8% by Q4 this year, close to the average bottom ten Q4 GDP forecasts in the February Blue Chip (1.7%), though similar to the 2011 GDP performance.


Oil and Fed Policy

The reaction of monetary policy to increasing energy prices is necessarily situational. A persistent rise in the oil price that feeds into inflation expectations would require a much different policy response from an oil price rise that imparts a temporary boost to headline inflation. In his Monetary Policy Report testimony last week, Fed Chairman Bernanke did not dwell on recent energy price movements. But even his limited comments were telling:

“Looking farther ahead, participants expected the subdued level of inflation to persist beyond this year. Since these projections were made, gasoline prices have moved up, primarily reflecting higher global oil prices--a development that is likely to push up inflation temporarily while reducing consumers' purchasing power. We will continue to monitor energy markets carefully. Longer-term inflation expectations, as measured by surveys and financial market indicators, appear consistent with the view that inflation will remain subdued.”

The critical word in Bernanke's text is “temporarily.” It implies that the chairman, and his many like-minded colleagues on the FOMC, are more concerned about the headwinds that higher gasoline prices might impose on economic growth than about gasoline’s potential influence on general price levels and inflation expectations. The menu of policy responses, then, includes doing nothing and easing further. Tighter policy in this scenario would be seen by the majority of FOMC voters as a dangerous over-reaction.

This view would be consistent with earlier research performed by Professor Bernanke (and colleagues) in the 1990s, which showed that "a substantial part of the recessionary impact of an oil price shock results from the endogenous tightening of monetary policy rather than from the increases in oil prices per se."

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SheepDog-One's picture

OH I see....now we're COMFORTABLE with high prices! Well isnt that special.

Schmuck Raker's picture

I tell ya one thing SD-1, I'm far more comfortable with high gas prices than I am 4-month time increments on graphs of economic data. Giving me the heebie-jeebies.

spiral_eyes's picture

Consumption has dramatically fallen, while gas prices continue to rise. How high would they be if consumption had not fallen? And how much will consumption have to fall to stave off further rises?


boiltherich's picture

Try graphing the price of a can of chunk white tuna on there and you will see that gasoline is indeed cheap.  $2.59 at Slaveway, only up $1.00 so far this year, I even thought it had to be an error so I asked the customer service desk but no, $2.59 is the shocking new price.  And I saw my first $80 roast too the other day.  Even lillys have gone from $6.99 to $9.99, so I am thinking the Fed really needs to push a few trillion more into the bankster/speculator accounts because I need to lose another 15 pounds before May.  Coffee has come down a little but I bought a can the othr day and it tasted horrible. 

Oil is used in every thing we buy, if not directly then indirectly for transport.  The only way we will get price stability back is to gut the speculators.  And that is not going to happen till we gut the banks, and so on till there is no more Fed and we use real money that rings when you drop it on a stone floor.  We will see how many people are willing to bet REAL money on commodities if it means the possibility of real losses, this free electronic fiat for bankers only will result in a socialist revolution if just a few more percent of America enters permanent poverty. 

StychoKiller's picture

Re:  Coffee; buy whole beans and grind it at the store (or at home if ya got a grinder!), then be sure to store it in an airtight container.  Coffee oxidizes, which makes it taste more bitter than it should.  Buy a French press coffeemaker and heat the water to around 190° F.  Excessive heat is the other enemy of a good cup of coffee.

JPM Hater001's picture

It's the new normal.  Where have you been? 

Thorny Xi's picture

The recent upturn in consumer credit card balances reflects the increase in oil costs, little more ... demand is dropping but below a certain level, inelastic.

LawsofPhysics's picture

yep.  The demand in America is dropping, but it can only go so low.  moreover, demand in the rest of the world remains constant and growing.  The american demand and the dollar become less relevant every day.

trav7777's picture

lol, it can and WILL go way lower

Sutton's picture

Read the final high lighted statement.

Who will rid me of this troublesome Central Banker?

SheepDog-One's picture

right, all is well, as long as the free money nozzle is turned full blast and never even hinted at interrupting the flow.

Flakmeister's picture

Ah... a trip down memory lane....



April, 2004: Saudi Oil Is Secure and Plentiful, Say Officials

“Saudi Arabia now has 1.2 trillion barrels of estimated reserve. This estimate is very conservative. Our analysis gives us reason to be very optimistic. We are continuing to discover new resources, and we are using new technologies to extract even more oil from existing reserves,” the minister said.

Naimi said Saudi Arabia is committed to sustaining the average price of $25 per barrel set by the Organization of the Petroleum Exporting Countries. He said prices should never increase to more than $28 or drop under $22. “This is a fair price to consumers and producers. But, really, Saudi Arabia and OPEC has limited control on world markets,” said Al-Naimi. “Prices are driven by other factors: Instability in key oil producing countries; industry struggles to produce specialized gasoline; and the resulting strains on refineries to meet local demand.”

“Saudi Arabia’s vast oil reserves are certainly there,” Naimi added. “None of these reserves requires advanced recovery techniques. We have more than sufficient reserves to increase output. If required, we can increase output from 10.5 million barrels a day to 12-15 million barrels a day. And we can sustain this increased output for 50 years or more. There will be no shortage of oil for the next 50 years. Perhaps much longer.”

SheepDog-One's picture

Massive bubble top here...makes the real estate mortgage bubble look like nothing. At that point DOW 14,000+, oil at around $30...now we're 13,000 and oil $106, plus about $20 trillion new holding it all up. 

Flakmeister's picture

No bubble in oil.... if 2008 was a bubble, why are we back to essentially the same levels??

Bubbles do not reflate in 4 years...

trav7777's picture

some dude with an "IQ of 161" told me that there was no problem, therefore your entire argument about peak oil is rejected.

LawsofPhysics's picture

Ah yes, and pigs can fly, they just choose not too.

Taint Boil's picture



“My father rode a camel. I drive a car. My son flies a jet-plane. His son will ride a camel.”

—Saudi saying

LongSoupLine's picture

Uhhh, where's the APPL line on the chart?

GoinFawr's picture

 neat trick,  'self-deflating QE'

"Balisarius wore this before he died.
You know, I actually
saw him change lead into gold.
I could never do that.
Mmm... Too bad.
You'd have stood
to inherit some real wealth. "-Ulrich

Piranhanoia's picture

What do we think might have happened if this were a very bad winter spring?    Consequences?

YesWeKahn's picture

"$10 increase in the price of crude oil raises headline CPI inflation by 0.3-0.4 ppt."

Bernanke doesn't count gas price in his inflation projection

firstdivision's picture

I hope that $100/bbl is Brent and not WTI, otherwise they're a complete moron to think it'll add to disposable income.

Flakmeister's picture

Those rig hands in the Bakken are likely the only real source of rising disposable income....

trav7777's picture

yeah...and any pipeline engineer

mantrid's picture

but but but keynesians say if we break windows and throw oil into the sea then the economy will grow grow grow, employment will soar soar soar. everyone will get a job as there will be so much stuff to transport by feet

chump666's picture

The FED are confused idoits, like the ECB.  With their QE3 nonsensical jawboning they just sent oil bid, which caps rallies.  3pm sell is on, tight ranges and the HFTs look frisky.

Central Banks are losing control of the market.

Assetman's picture

Was Bernanke's recent less unconditional dovishness an implicit effort to 'tighten' expectations and manage the war-premium out of oil prices?

The short answer is "yes".

The only problem is that he cannot weasel out of higher oil/gasoline prices by verbal massaging alone.  Why?  Because oil pricing are already rising in the face of flat/falling demand.  Everybody is beginning to clue in that higher oil prices are a "dollar-thing", and thus, even more vulnerable to a potential global supply shock. 

The Fed needed to communicate a real plan to keep a lid oil-based inflationary pressures at bay-- while still buying the crap out of longer-term Treasuries beyond Operation Twist. 

The sterilized QE plan is actually a pretty decent answer from Ben the Sociopath.


Bunga Bunga's picture

Iran is a nice tool. It brings up the oil price, so they can blame high oil price for bad economy.

johnjb32's picture

Now, you have to go look at the chart that follows to get a knock out visual on the correlation between oil price and GDP. -- Michael C. Ruppert