Global markets have settled from last week's turmoil worry about deflation has returned with crude oil plunging by 25% since the peak in June.
Back then, it was trading around $115 per barrel: Now it's only $80 per barrel. There is an over-supply of oil as key OPEC members (Saudi Arabia) continue to supply the same amount of oil, even when global demand has fallen. U.S. production also has exploded since 2008, thanks to technological advances in hydraulic fracturing and horizontal drilling.
Given the weaker oil prices, the recent and immediate price action in the foreign exchange market was to quickly get out of oil-exporting countries' currencies. For instance, both the Norwegian krone and Canadian dollar are at 5-year lows, while the Russian ruble continues to hit all-time lows almost every day.
Governments were budgeting their GDP growth based on an average oil price of more than $100 per barrel for this year. Countries like Iran, Venezuela, Iraq and Russia can only balance their budgets within a $100 - $135 per barrel range. If oil prices stay low, these countries will take a significant blow in their fiscal positions.
So are these low oil prices piling on to deflationary fears? Maybe, but it is almost certain that in past years, the current geo-political events surrounding the world - especially in the Middle East and Russia - would have led to significant spikes in oil prices. This time we managed to avert that scenario. This is significant and timely too, as we enter the winter months. A lower heating bill is actually a relief for consumers. Meanwhile, these oil-exporting countries that were overestimating oil revenues may have to reconsider using oil as a political weapon.
Our View: Lower oil prices are a two-edged sword. Yes, it could be deflationary, but the positive side is that it serves more as a form of looser fiscal policy, like an energy tax break. Many countries around the world had been struggling with large fiscal deficits, implementing more austerity measures than fiscal stimuli. Lower oil prices are good for consumers and for the economy as a whole.
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