The price of oil has fallen off a cliff in 2014 to the surprise of the market, where an increase was expected amid heightened tension in the key oil producing regions of Russia and the Middle East.
According to FE Analytics, Brent crude is down more than 35 per cent this year, although all of the downside has occurred in the past five months.
Performance of index in 2014
Source: FE Analytics
Potter (pictured) says the divergent effects of this plunge will mean big winners and losers across global markets with the interplay between the two ramping up volatility.
“Oil – for good and bad – will be the major determinant of what happens to sentiment, equities, volatility, currency and bond yields [next year]. It will have a massive impact on all of these things in 2015,” he said.
“The fact that the oil has gone down from $110 per barrel at the start of the year to $66 is a massive reduction in a short period of time.”
He says cheaper oil will boost consumption but destabilise emerging markets, mostly through currency devaluations.
“With global growth is rising, more than people had been forecasting six months ago, because of the oil benefit will be seen as positive for companies which will bring forth rising bond yields,” he added.
“People will therefore bring forward the date at which they expect rates to rise, and the speculation around that will cause volatility. We will see various periods next year when the ebb and flow of sentiment around rising growth and emerging market currency issues is causing volatility.”
“On the one hand you have a world economy that – apart from the US – is still struggling to get traction, particularly in Europe, while Japan is doing its best to do QE to force an improvement but China is slowing down. Interest rates are still low and there is little talk of a rate rise, except in the US.”
He says its impact on emerging markets’ currencies, which tend to be exporters of oil, will be severe.
“Those currencies have already been suffering significantly and this tends to act as a destabiliser to those countries. A lot of these countries depended on the oil revenue but because their currencies are down 20 to 30 per cent everything they import – food stuffs, commodities, etc – are much more expensive.”
“Net inflation therefore goes through the roof which causes more angst across the emerging markets.”
“On the flipside there will be a massive stimulus to the world economy. Lower costs for energy – apart from the US which is largely self-sufficient – petrol bills and transportation costs will more than dwarf the problems it causes.”
Potter says in particular net importers of oil such as Japan and Europe will get a positive kick from consumers being able to spend a more.
“However, what happens between these times will cause some volatility because if one day emerging markets are under pressure and can’t pay their debts and refinance or default those worries will spook the markets.”
“On the days when you have emerging markets in upheaval because of defaulting you may see bond yields falling.”
Julian Jessop, chief global economist at Capital Economics, agrees that an extended period of lower oil prices should be positive for the global economy as a whole, including key emerging economies led by China and India.
“As well as representing a substantial transfer from oil producers to consumers, who tend to spend more of their income, it will also help to keep inflation low and ease current account imbalances. However, we also see scope for renewed worries about the impact on the big losers, including geopolitically important economies like Russia, and on the oil industry itself,” he said.
David Jane, manager of Miton’s multi-asset portfolios, says the rapid fall in the oil price may have negative implications for US jobs and capital expenditure in certain areas with the overall effect uncertain.
“At this point it is unclear whether this is a net positive or negative for the US economy. There are, however, some areas where the implications appear to be wholly positive,” he said.
“In certain energy intensive areas of the market, such as airlines and cruise ships, there is a clear and fairly immediate benefit and these stocks have been rising hand in hand with the falls in oil. However, we are now considering the medium-term implications of lower energy costs for other sectors and economies.”
While he agrees with Potter that cheaper oil will lead to more consumption in oil importing economies like Japan and Europe, he says the effect in emerging markets is less than clear.
“Many south-east Asian economies are both consumers and producers of oil and the effects here are much less clear, particularly on the government finances in the region. In Indonesia in particular, this is compounded by high dependency on other resources such as iron ore and high levels of debt,” Jessop explained.
“We see Asia as a particular risk of unintended consequences from the current environment. The other obvious risk is some of the highly energy dependent economies such as Russia, where both the rouble and bonds have been falling precipitously.”
