Surprise! For the first time in eight years, the price of a barrel of oil slipped below $10 a barrel. At the same time, the yield on the 30-year Treasury bond touched 7.25 percent, the lowest level in eight years. Upon further reflection, this is also the first time in years that the price of a barrel of oil has fallen below the cost of a good bottle of scotch. We are not advocating switching to guzzling west Texas crude, or Brent crude from the North Sea or even Saudi light, but at the same time one cannot help wondering if interest rates can decline much further. The driving force in the percipitous decline in rates so far this year has been the equally staggering decline in oil prices. In fact, if you were to make an overlay of the yield decline in the 30-year T bond, it would almost identically match the drop in oil prices since November.
It would appear that for interest rates to decline further, oil prices would have to move lower and/or the economy would have to fall into a recession. Some economists feel that a recession cannot be ruled out. They point to an already weak economy, agricultural problems, the overbuilding in commercial real estate, high consumer debt, the economic and financial havoc being created in states that have petroleum related industries, and now, increasing auto inventories. One economist sees these many problems resulting from the deflationary activity within the economy. In this scenario, lower interest rates will be needed to stave off a recession and to stimulate the economy.
On the other hand, the fact that interest rates, especially mortgage rates, are at such low levels causes other analysts to feel that the economy will bottom over the next several months and will then improve markedly during the second half of 1986. They also see the lower dollar leading to an increase in the demand for our exports, thereby helping to rejuvenate the manufacturing sector of the economy and eventually reversing the merchandise trade deficit.
Lower interest rates worldwide will help to spur the economies of the industrialized nations, thus increasing the demand for the commodities of the Third World countries, which, in turn, aids their debt problems. However, a byproduct of all these good events will be the increase in the demand for funds, which will in time lead to higher rates. In this scenario, the rise in rates is expected to be moderate.
The maddening aspect to all of this mental gymnastics is that there are many contradictory pieces of data in the wind. Further, neither of these two scenarios takes into account the possibility of a collapse of the dollar or a sharp rebound in the price of oil. And nothing is mentioned concerning our federal budget problems, while it is assumed that the merchandise trade problem, as well as the budget deficit, will be solved in time. Whatever the future holds in store for us, it is still a tough call as to what will happen.
Maybe we should just acquire a taste for a good grade of refined oil and be done with it.