Fed Rate Hike Causes Oil Prices To Hit Their Lowest Level For The Year
The fate of commodity markets remains dubious, despite the OPEC’s efforts to stabilize crude oil prices. Oil prices had traded above the $50 per barrel mark for most of the March quarter driven by the OPEC’s production cuts of 1.2 million barrels of oil per day (Mbpd). However, the surge in the US oil production and inventory levels has dampened the impact of these output reductions. In fact, even after the oil cartel recently decided to extend the production cuts until March 2018, the oil prices did not witness a significant improvement (For further details read: OPEC No Longer Controls The Oil Game). On the contrary, oil prices have plunged to below $45 per barrel for the first time in 2017, due to the interest rate hike announced by the US Federal Reserve last week. While we believe that the negative impact of increasing interest rates is likely to be short-lived, the unbridled growth in the US oil supply and stockpile could delay the revival of oil prices.
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Impact of Fed Rate Hike
The downturn in commodity markets over the last couple of years has left crude oil prices susceptible to any change, trivial or significant, in the global markets. The most recent of such events is the interest rate hike announced by the US Federal Reserve last week. The government body raised the interest rates by 25 basis points, taking the current rates to 1.25%. The central bank cited the country’s improving employment data, strengthening household spending, and business fixed investment as the reasons behind the rate hike. Further, the Fed is expected to raise the interest rates by an additional 25 basis points over the remainder of the year.
Now, higher interest rates tend to make dollar-denominated bonds more attractive, thereby strengthening the US dollar versus other currencies. For instance, the US dollar to Euro exchange rate rose from 0.891 on 14th June to 0.897 at present. Since crude oil is globally traded in US dollars, it is likely to become more expensive for other countries (with weaker currencies) to purchase a barrel of oil, which will, in turn, hamper the demand and prices of the commodity.
Source: US Energy Information Administration (EIA)
That said, we believe that the impact of increasing interest rates is temporary and is valid only in the short term. This is because on analyzing the graph above, one can clearly deduce that the last two Fed rate hikes, December 2016 and March 2017, have not had a lasting impression on oil prices. Although the oil prices have dropped almost 5% since the latest Fed rate hike, it is safe to assume that the impact of the news will die down soon. Thus, we believe that the long term prices of crude oil is more likely driven by factors, such as the US oil inventories, US oil production, and the OPEC production, that play a far more crucial role in the estimation of oil prices than the movement in interest rates.
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