Financial markets and world economy, though interconnected, stand diverged on where oil should go.
- It is quite evident, the equity markets hate falling oil, hence cheer rally in oil prices
- On the other hand, we have global economy which needs lower oil price.
Why global economy needs lower oil?
- Aggregate demand across the globe is weak and higher energy prices only reduces real income and therefore consumption. Therefore oil rally would only add to demand deficiency.
- In fact, oil rallies won’t last long since world is facing demand deficiency!
- Hence, until China sees successful rebalancing, low oil is a necessity and a new normal
But….there are financial markets and they love oil rally
- As of now a financial market crash is the last thing anyone desires, hence fresh sell-off in oil is undesirable.
- No wonder then, OPEC and non-OPEC members are attempting to work together!
- Financial markets love oil rally, however, as we have seen above low oil is a new normal and a necessity
Hence, an ideal situation is the one where oil consolidates and stays around $40 (+5/-5)
It is to be noted that oil is more likely to drop to fresh multi-year lows, however, OPEC and non-OPEC members would allow that to happen only after financial markets are comfortable with the new normal of low oil prices.