Since the night of Trump’s surprise win in the general election, the markets opened up a bull rally, the dollar strengthening and inflation expectations rising slightly, with no end in sight.
I took note that the oil market had hardly noticed (to some chiding of reasoning from a price change). Suppose that inflation expectations rise, and everything else remains the same, the price of oil should change upward slightly, which is what it did on the day after the election. But toward later in the day, as the dollar strengthened, WTI settled back down again to nearly unchanged. Really, I can’t think of a better gift to market monetarists who aren’t down and dirty into details as the oil market on November 9 that was absent of other oil news that might otherwise have caused a lot of noise.
Holding the oil market thought for a moment, being new to the macro scene, I have never seen this mix of indicators, and it was a little confusing. But thinking about the equation of exchange, it starts to become demystified.
MV=PY or, as some prefer to write, MV=NGDP
I like this equation because whatever gets done to one side has to be done to the other, and as well having properties that may keep people honest, it has a lot of general explanatory power.
We pretty much know that M is not stable, lately heading in the southern direction.
The markets are expecting a modest boost to P, and it looks like the expectation is for a bump to Y as well because the DOW and S&P 500 are soaring beyond any price adjustments from changes in inflation expectations.
If M is decreasing, and P and Y are expected to rise, the only thing left to explain this mix is V.
If this sort of back of the envelope analysis has any bearing on reality, there are some things that we can already know about how it may play out.
If you think that the markets already know what the Fed will do before it does it, then what we are looking at is a boost to RGDP with inflation remaining around the 2% mark. I can’t really say how big the boost will be, but I will be looking for an order of magnitude we have not seen since more than 10 years ago.
Just think about it. The Fed is busily lopping the base with RR’s, and despite this, expected changes in V are large enough to change the outlook considerably. Perhaps “roaring” isn’t exactly the term I should be using, but those at the Fed focus on P, while V and Y go where they like.
Now that I am done with the back of the envelope, the explanation seems to be as good as any other. But being in the habit of pessimism, I don’t know how real this is; sort of like waking up from a vivid nightmare and needing to pinch myself to be sure I am awake.
And this is where the oil market reaction may have some use, because whatever happens on the left side of the equation shows up on the right, and the oil market behavior appeared to be reactions to changes in expectations for P, not Y, while nearly every other market is expecting more Y. There might have been supply side noise in there on that day making it look like the market didn’t move. But if the expectation is to be able to just stick a drill in the ground wherever and whenever without a lot of hassle, that would have had an impact besides negligible.
I really wish the financial media would stop publishing rumors about OPEC agreements to cut output (Was this latest one like the 5th such agreement in as many months? I’ve lost count). OPEC is a dysfunctional organization, but they are not stupid people. They are all very well aware of the exercise in futility of out put cuts, the higher the price goes, the more American oil there will be, and the more market share they lose. They will cut output when pigs fly.