They may seem unrelated, but there are two key economic variables that will provide a great deal of insight into the world’s future growth prospects.
The first of these is the world price of oil. The second is U.S. housing prices.
A key factor that’s been holding back the world price of oil has been the European sovereign debt crisis. With the ongoing financial problems of Greece, Cyprus and Spain, to name the countries most clearly in distress, Europe’s growth has fallen well below potential. Europe has a 500-million population base. As such, it is the largest closely-knit consumer market in the world.
In turn, the economic malaise in Europe has been felt around the world. China particularly counts on export sales to Europe and those have been sadly depleted of late.
EU finance ministers have finally come up with a rescue plan for Greece that will hopefully put its financial problems on the back burner for once and all. (I’m well aware we’ve all heard this before, but there may be greater validity to the argument this time.)
There are several key components to the new package. Some interest payments have been suspended for up to a decade. Other interest rates have been cut. Repayment periods have been extended. And the European Central Bank (ECB) will return some of its interest earnings on Greek debt back to that desperate-for-cash nation.
Notably missing – ostensibly to keep Triple A-rated European nations happy – are measures that would directly forgive outstanding obligations.
Greece’s debt is now projected to fall from 190% of GDP in 2014 to 124% in 2020.
The nation has also been given two extra years to cut its budget deficit.
Other European countries will provide subsidies for Greek infrastructure projects once an operating budget surplus is posted.
Greece’s final debt repayment won’t take place until 2040.
If Greece is now truly on a viable recovery path, the economic prospects for the European Union will be much improved. One consequence is sure to be a greater demand for oil. Hence, the price of oil for European deliveries will have an upwards bias.
At the same time, oil prices will continue to be impacted by conflicts and tensions in the Middle East. The Syrian revolution and the Israel-Hamas clashes – while they do not involve any of the major oil producing nations – qualify as reasons to expect a risk premium.
The price gap between Brent crude (from the North Sea) and West Texas Intermediate (WTI) is near a record high. At times, it has approached $30 U.S. per barrel. At the time of writing, the price of Brent crude was $110.29 U.S. per barrel while WTI was listed at $86.93.
The biggest reason for the price discrepancy is that WTI prices are lower than they should be.
The largest oil hub in the southern U.S. is located at Cushing, Oklahoma. There’s been a build-up of inventories at that site thanks to expanded supplies as more and more shale rock deposits are tapped.
Also, Cushing has limited pipeline capacity to the Gulf Coast. That means U.S. oil isn’t making its way to eager customers in the emerging world. As a result, it’s missing out on higher potential prices.
Industry experts are advising President Obama to approve TransCanada’s XL Pipeline project. The expectation is that oil flowing further south from Cushing through the XL system will be able to earn a significantly higher return because it will take crude to refineries that can supply offshore customers willing to pay a higher price.
By the way, the Brent price is used in two-thirds of the world’s foreign trade transactions in crude oil.
The second of my key indicators is U.S. home prices. An upward trend is positive for the whole economy.
A stronger housing market has clearly taken hold in the U.S. Housing prices are on the mend.
Purchasers are no longer standing on the sidelines waiting for prices to drop further.
Homeowners are feeling more confident about their finances, knowing that their primary asset is going up in value.
It’s not just coincidence that the U.S. Conference Board’s consumer confidence index in November rose to its highest level (73.7) in more than four-and-a-half years (i.e., February 2008’s level of 76.4).
The S&P/Case-Shiller existing homes price indices advanced for the sixth month in a row in September. On a year-over-year basis, the 10-city composite index was +2.1% while the 20-city composite was +3.0%.
The individual cities with the largest year-over-year price increases were: Phoenix, +20.4%; Minneapolis, +8.8%; San Francisco, +7.5%; Detroit, +7.6%; and Miami, +7.4%.
Only one city registered a year-over-year price decline in the latest month, Chicago at -1.5%.
Earlier in the month, the National Association of Realtors indicated that the median price for all existing housing types in the U.S. was +11.1% year over year in October.
Finally, there is a third measure of U.S. home prices. It’s calculated by the Federal Housing Finance Agency (FHFA) and is based on Fannie Mae and Freddie Mac mortgage signings.
It’s a seasonally-adjusted purchase-only index for single-family homes. It tracks home price changes in repeat sales or refinancings of the same properties. The mortgages have been purchased or securitized by Fannie Mae or Freddie Mac since January 1975.
The FHFA’s house price index (HPI) recorded a 1.1% increase from the second quarter to the third quarter of this year and a 4.0% advance compared to the third quarter of last year.
The FHFA’s month-to-month change in September was +0.2%.
While the picture is looking up, there are still headwinds for U.S. home prices. The FHFA’s press release says there continue to be the following drags on U.S. home prices: “stagnant income growth, high unemployment levels, lingering uncertainty about the macro-economy, and the large number of homes in the foreclosure pipeline.”
Also be aware that we are now entering the seasonally weak part of the year (i.e., winter).