Poor Goldilocks

The idea that the US – and by extension much of the rest of the world – can secure itself a Goldilocks outcome to the current inflation vs recession battle is looking less and less likely.

The Goldilocks outcome, neither inflation becoming uncontrollable nor a recession accompanied by high unemployment, is what the US Federal Reserve (and other central banks) hopes for, but it’s become more remote, thanks in part to the resurgence of crude oil prices. Crude oil may be internationally traded and priced in dollars, but the Fed can’t control its price. That is set by supply and demand, and as important, the market’s perception of what that supply versus demand balance will be.

In early March, the Opec+ group – the Organisation of Petroleum Exporting Countries plus non-Opec members – said it would cut crude oil production by 1.16 million barrels per day (bpd) from May through to the end of this year. This throws a huge spanner in the works. Analysts had been pencilling in a fall in crude oil prices earlier this year; the US Energy Information Administration (EIA) estimated in early March that Brent would average $77.57/barrel in 2023.

That’s now out of the window. The international benchmark price – that for Brent crude – rose about 6% to $85/barrel the day after this latest cut was announced. This cut follows a production cut of 2 million bpd from last November. Opec+ members want to put a floor to the crude oil price of around $80/barrel.

Saudi Arabia is the second biggest and the most influential Opec member. The Middle East country requires this year a fiscal breakeven oil price (the minimum price per barrel needed in order to meet its expected spending needs while balancing its budget) of around $78/barrel; Russia, which is part of the Opec+ grouping, needs a fiscal breakeven price in 2023 of about $114/barrel.

Prices have now returned to close to where they were shortly after the Russo-Ukraine war started. And they will probably push higher. Goldman Sachs increased its forecast for the benchmark Brent crude oil price by $5 to $95/barrel for December 2023 and raised that of December 2024 to $100/barrel.

The International Energy Agency (IEA) in March already raised its estimate for global oil demand this year to an average 102.02 million bpd, 2 million bpd higher than last year. According to the IEA the second half of 2023 will see the global crude oil market balance move from surplus to deficit. The crude oil market is getting tighter; prices will rise; inflation will make a come-back.

Jerome Powell, chairman of the Fed, said a year ago that a $10 increase on a barrel of crude oil raises inflation by about 0.2% and sets back economic growth by 0.1%. Motorists in the US will shortly see the pump price rise by as much as 15 cents/gallon; by the time we get summer in the northern hemisphere the average US price for regular gasoline is likely to be some $4/gallon. Higher crude oil prices will feed into higher prices for just about everything – transport of all products, fertilizer, plastics, heating; you name it. Food-at-home prices in the US rose by an annualized 9.5% in February against 10.1% in January but they accelerated from 8.2% to 8.4% for food-away-from home. In the UK, food inflation in March was an annualized 18%, against February’s 16.7%.

Slowing global economy?

Crude oil prices increased 43% year-on-year in 2022, on the fear (and reality) of less supply from Russia; the IEA predicted last year, after the Russian invasion of Ukraine, that as much as 3 million barrels per day of Russian supply, almost 3% of the total global output, could be “shut in” (meaning lost to the market). That gloomy forecast did not come to pass; Russia was understandably determined (for political as well as economic reasons) to find new buyers after the imposition of sanctions. It managed to divert much of its crude oil from Europe to Asia; more Middle East and non-Russian oil arrived in Europe. From $133/barrel last March the crude oil price averaged in 2022 almost $101/barrel. The sliding price came as a great relief to many central bankers trying to wrestle down inflation.

But the higher prices for oil and petrol now imminent in Europe and the US as a result of Opec’s cuts jeopardises the fight against inflation all around the world. Opec+ will achieve a higher oil price – but it may also drag the global economy into a recession. Deutsche Bank analysts late last year said “there is a growing consensus that [2023] is shaping up [to] be the third-worst year for global growth so far in the 21st century, behind only the pandemic year in 2020 and the aftermath of the financial crisis in 2009”. Kristalina Georgieva, managing director of the International Monetary Fund (IMF) last week forecast that the global economy faces years of relatively slow growth, expanding at an annual average rate of 3% for the next five years, the weakest projection for medium-term growth since 1990. IMF projections are, like all macro-economic forecasts, unreliable; an analysis of its record found in 2018 that “over the last 27 years, the IMF has predicted every October that an average of five economies will contract the following year. In practice, an average of 26 have contracted”. Nevertheless there are many indicators of an economic slow-down; global shipments of personal computers, for example, fell by almost a third in the first quarter of 2023, according to the International Data Corporation.

And Opec’s decision has political as well as economic repurcussions.

Since the Truman Doctrine in 1947 the US has committed itself to provide political, military and economic assistance to “all democratic nations under threat from external or internal authoritarian forces.” It thus took on the role of the world’s policeman, albeit one frequently carried out clumsily and immorally. This doctrine in any case contradicted the view of one of the founding fathers, George Washington, who issued a Proclamation of Neutrality in May 1793, threatening legal action against any American giving assistance to any country at war. Isolationism is as much part of the soul of the US as the enforcement of rules on unruly nations.

So, international policeman or go-it-alone champ? This issue is now more sharply in focus than since the Second World War. A recent NBC News poll found that, while two-thirds of Democrats support more funding to Ukraine, just one-third of Republicans do. But it’s not just the war in Ukraine, which has now cost the US more than $70 billion. Continued support for Ukraine will diminish as we approach the next US Presidential election, and could evaporate entirely if a Republican President next wins office. Tensions with China over Taiwan seem to build week-by-week. Perhaps most indicative of the emergence of a new world order is the restoration of relations between the Sunni-majority Saudi Arabia and the Shia-majority Iran – after decades of mutual hostility. And moreover this harmony was brokered by China, not the US. Since 1973 Saudi Arabia has been seen as a client state of the US, thanks to their mutual agreement to trade oil for Dollars and to invest the profits in US Treasury bonds. Saudi Arabia is now willing to trade its oil for currencies other than the Dollar. The international policeman role of the US is threatened.

It’s like some great external force has thrown all the cards in the air. We need to take shelter while we watch how they fall.