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How Will Rising Oil Prices Affect the Economy?

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RANDY FREDERICK: For decades conventional wisdom was that low oil prices were good for the economy, but that was before crude prices crashed all the way down below $30 a barrel back in 2016. Since then, prices have risen all the way back up to almost $70 per barrel, sparking renewed concerns of risk to the upside. Jeff Kleintop joins me for this week’s Stock Market Report to talk about whether the current trend in oil prices is positive or negative for the economy.

So, Jeff, economists used to warn us about high crude prices because high prices can be a drag on both consumers and businesses, and, of course, that can stifle economic growth. And, in fact, back in the 1970s, we even had economic recessions caused by high crude prices. But now it seems like economists are confident that growth can continue despite the fact that oil prices have more than doubled in the past two years. So what is the story here?

JEFF KLEINTOP: Well, Randy, the doubling of U.S. oil production over the last decade means U.S. energy businesses stand to benefit from higher oil prices, and the tax cut in the U.S. is helping offset the higher prices at the pump for U.S. consumers. But even outside of the U.S., other parts of the world are weathering this rise in oil prices pretty well with pretty solid first-quarter economic growth. And I think there’s three reasons that the current rise in oil prices aren’t seen as a threat to global economic growth. And the first is that the percentage rise in oil prices has been much smaller outside of the U.S., and that’s, in part, due to the fact that the dollar has depreciated by quite a bit over the last year or so. And we also are seeing much higher fuel taxes in Europe and Japan, and that helps to cushion the rising crude prices when it comes to prices at the pump. In fact, in Europe, pump prices are unchanged from a year ago. The second reason is robust global economic growth helps to offset, absorb, some of the impact of those higher oil prices. In fact, last week, the International Monetary Fund upgraded their outlook for economic growth. In fact, they raised their 2018 GDP forecast for nearly every one of the major economies that they cover. And, finally, there’s a key difference between a supply- and a demand-driven increase in oil prices. While both may be playing somewhat of a role here lately, a demand-driven increase is very different than when purely driven by a supply shock.

RANDY: That makes sense, but if I heard you correctly, it sounds to me like a pretty significant secular shift has taken place. So does that mean that high oil prices no longer pose a downside risk to the stock market?

JEFF: Well, for now, the rise is helping to lift corporate earnings, and stocks have been tracking earnings. Energy companies in the MSCI All-Country World are expected to post 21% earnings growth from a year ago in the first quarter, and in the second quarter, earnings are expected to be up 70% for that sector of the stock market, according to FactSet data, so it is helping to support the stock market. But, look, a continued rise in oil prices could eventually cut into consumers’ pocketbooks. It can also force central banks to rein in stimulus more aggressively, more rate hikes, and to clamp down on the potential rise in inflation, and that could undermine some of the growth in the economy. But for now, most economists would rather see oil prices climbing over $70 than dropping back down below $30.

RANDY: So a good reminder, the risks are never completely gone. But at least for now, it sounds like it’s more net positive than net negative.

Listen, you can read more from Jeff in the Insights and Ideas section on Schwab.com. You can follow Jeff on Twitter @JeffreyKleintop. And, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

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Definitions

Definition of MSCI: A market-capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International, and is comprised of stocks from both developed and emerging markets.

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