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Drop In Oil Prices: Economic Implications

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Jeffrey Rosenberg takes a closer look at the global drop in oil prices and reveals how this affects supply, demand and U.S. monetary policy.

The sharp, greater-than-40% drop in oil prices from its highs in June reflects dramatic changes in the marginal supply of oil, shifting expectations for demand and, critically, a change in the outlook for monetary policy. The resulting stronger dollar is weakening its equivalent measure in the price of oil. Today, I’m going to explore why oil prices have declined and what this means for the economy.

drop in oil prices to five year lows

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Market Realist – Oil prices (BNO) have been in free fall for months now. There’s been an unprecedented, near 50% drop in oil prices since June, and the bloodbath continues unabated. On December 12, 2014, US oil prices, as measured by West Texas Intermediate, or WTI, slid to $57.81 a barrel for the first time since May 2009. This week saw US crude close below $56 a barrel on Monday. The international indicator of oil prices, Brent crude, also fell to a fresh five-year low of $61.73 a barrel on Friday.

drop in oil prices divergence with S&P 500

Market Realist – The precipitous drop in oil prices marks six straight months of losses for the commodity. This is the longest losing streak for the energy sector (XLE) since the US financial crisis (XLF) of 2008. The energy sector of the S&P 500 is down 16.5% for the year, as you can see in the above graph. That’s stark contrast to the broader index, which is giving 8.3% returns year-to-date. The declining oil prices have also led to serious side-effects, including a fall in the price of gold (GLD), deflationary threats, and a weakening in economies such as Russia and Venezuela.

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The drop in oil prices is also affecting the global equity markets (QWLD). The S&P 500 (SPY) declined by 3.5% last week, making it the worst weekly decline in the past two years. The Dow Jones Industrial Average Index suffered a weekly decline of 3.8%, the steepest slide since 2011. Volatility, too, came back in a big way with a sharp jump of 78% in VIX levels (VXX) last week. This suggests that stocks could be in for a turbulent time ahead.

While the declining oil prices could be a boon for consumer spending (XLY), it could have disastrous consequences for economies dependent on oil exports. In this series, we’ll discuss the three factors that are precipitating a drop in oil prices—demand, supply, and the dollar. We’ll also discuss the economic implications of the drop in oil prices as well as who the winners and losers of the decline will be.

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