Marcus Svedberg of East Capital -

The oil price has dropped roughly 50% over the past six months and most analysts are now busy updating their macroeconomic and equity models with the new assumptions for the oil price. There is still a lot of uncertainty as there are supply as well as demand factors – and perhaps some politics in addition – behind the sharp correction. We believe the price will remain volatile in the coming months, possibly moving even lower from current levels, before recovering during the second half of the year.

Speculating what the average oil price will be for the year may not be very productive at this point, but it should be clear the price will be significantly lower than in the previous few years. But for the sake of the analysis, one can use consensus or forwards to argue that the average price for the year will be around $60 per barrel for Brent. That would mean the oil price will be roughly $40 lower than in 2014 and $50 lower than the previous three years when it was remarkably stable around $110.

The most obvious impact is that this is positive for oil importers and negative for oil exporters. And it is particularly positive for importers with large current account deficits or inflation problems, and particularly negative for exporters with high fiscal break-even limits that do not have large financial buffers.

Source: MacroBond

But the most interesting thing about the falling oil price is that it is exacerbating a number of underlying trends.

Disinflation, deflation

In general terms, it is putting even more downward pressure on inflation. Consumer prices in most major economies started to decelerate in the second half of 2014, with the Eurozone even falling into deflation in December for the first time since the global financial crisis in 2009. This suggests that the European Central Bank (ECB) will be even more likely to embark on quantitative easing, possibly as soon as the end of January, while the US Federal Reserve’s expected first rate hike may be delayed even further. It is not only reinforcing the downward pressure on consumer prices, but also exacerbating the weak producer prices, especially in a number of large emerging economies. The CE3 (Czech Republic, Poland and Slovakia) economies are already in deflation, while producer prices in Asia have fallen even deeper into negative territory lately.

Source: MacroBond

Secondly, lower oil prices also point to the global economic recovery being even stronger. Lower oil prices are a global stimulus that will be more important for economic growth than the various financial stimulus packages. The International Monetary Fund (IMF) argues that it is a “shot in the arm” that will add between 0.3% to 0.7% to global growth in 2015 and 2016 by boosting consumption and decreasing the cost of production. The World Bank has come to a similar conclusion, arguing it will add 0.5% to global GDP in the medium term. The gains are, on the one hand, unevenly distributed between importers and exporters; and, on the other hand, between importers. Economies with little or no oil production as well as those with high a degree of energy intensity stand to benefit the most. Most emerging markets are winners in this respect, with India and Turkey perhaps the most obvious winners. Russia, Nigeria and the large oil producers in the Gulf are the most obvious losers.  

Illustratively, the oil price drop is making an already bad economic situation in Russia and in a number of other energy exporters even worse, while the opposite is true for Turkey and other large energy importers, especially in Asia.

At $60 oil, Russian growth may contract more than 4%, while Turkish growth should be able to grow more than 4%. Similarly, inflation decelerated to 8.2% in December in Turkey, and should continue to fall in the coming months, while it accelerated to 11.6% in Russia. The Turkish central bank is expected to ease rates in the coming months, which should boost growth further, while the Central Bank of Russia may be forced to make another rate hike if the oil price continues to slide. The Russian market has, as a result, once again become a derivate of the oil price. The ruble is once again reacting very strongly to movements in the oil price. This is not only a result of the oil price being more volatile, but also an effect of the Western financial sanctions and the fact that the currency is now floating.   

The most obvious trade right now thus seems to be one that favours oil importers at the expense of exporters. In Eastern Europe, it is easily done by going overweight Turkey and underweight Russia. It is less clear cut in other parts of the world, even though there are some likely winners and losers. It is, at this point, important to emphasize the weak correlation between short-term macro and stock market developments. That Turkey is looking better than Russia from a macro perspective does not necessarily mean that the former market will outperform the latter. This is partly because some of this is already priced in, as the Turkish stock market was up more than 30% in 2014, while the Russian market was down more than 35% (both in euro terms).

Also, it is tempting to look back to 2009 when the Russian economy contracted almost 8% and the stock market rallied over 100%. Previous performance is certainly no indication of future performance, but at least the oil price, which arguably is the most important factor for the Russian market, looks set to repeat the 2008-2009 trend. But the political backdrop has changed and the sanctions game may make this year different.

At the end of the day, it may be a year of two halves. A first half of the year dominated by falling oil prices and ECB stimulus, while the second half of the year could be characterized by rebounding oil prices and the first US interest rate hike. That would mean that different markets are likely to perform at different times. In Emerging Europe, as is often the case, the new EU markets in Central Europe and the Baltics seem like the safest but perhaps not the most exciting bet, in-between the extremes of Russia and Turkey.