Has oil’s demand destruction already arrived?
According to the International Energy Agency (IEA), sky-high oil prices are already ‘hitting demand’. The agency warns that this could contribute to a global slowdown. "The growth in world oil demand is showing signs of slowing over the last few months, affected by very high prices." The IEA hasn’t changed its 2011 forecast though. It still expects global oil demand to rise 1.6% this year.
Prices could level off or drop without a slowdown in growth, the IEA says. Nevertheless, my sense is that a global slowdown which brings energy prices to heel without precipitating a recession would be a good outcome. As I wrote this past weekend, inflation expectations have been rising globally.
They are still anchored but they will not be if they continue to rise any more. And if inflation expectations become unanchored, it will mean that policy tightening will have to be much more aggressive – and that leads us back to debt deflation in a hurry –exactly the problem CBs wish to avoid.
Federal Reserve Vice Chair Janet Yellen echoed these comments in a speech she delivered yesterday. Cardiff Garcia of the Financial Times covered Yellen’s speech in an insightful article yesterday, noting that Yellen gave us the usual defense for the Fed’s policies. But he noted the following line in her analysis, adding emphasis to the critical part:
Turning now to the outlook for U.S. consumer prices, I anticipate that the recent surge in commodity prices will cause headline inflation to remain elevated over the next few months. However, I expect that consumer inflation will subsequently revert to an underlying trend that remains subdued, so long as increases in commodity prices moderate and longer run inflation expectations remain reasonably well-anchored.
I think that’s the right analysis. I am less sure that consumer inflation will revert to trend. But Yellen is arguing that Central banks should focus on core inflation because she believes the rise in commodity prices is transitory.
At present, however, you can see inflation expectations rising in a number of different markets. Articles at Credit Writedowns have reported on inflation concerns in the U.S., in Latin America and in China in particular. Despite Yellen’s defense of the Fed’s QE policy, it is probable that quantitative easing has contributed to the rise in U.S. inflation expectations. What we would like to see is commodity prices falling or stagnating. And that would certainly be the case if demand destruction is already beginning as the IEA analysis suggests. Moreover, QE is ending in June. So that won’t be a factor in inflation expectations. The ‘goldilocks’ scenario would be moderating commodity prices, followed by moderating global growth, followed by an increase in growth as inflation expectations come down.