Politics & Policy

Our Well-Oiled Economy

Let oil prices be your interest-rate guide.

The 10-year Treasury note is known as a market bellwether. And when it jumps we often hear a familiar tune.

In the past 30 days, the yield of the 10-year note has spiked from 4.8% to 5.4%. That’s a big increase. Numerous analysts have explained this rate jump in terms of an overly rapid economic recovery and the likelihood of rising future inflation. So, as the song goes, everyone now thinks the Fed is going to raise interest rates in order to calm down the economy and ward off inflation.

It’s a tired tune. And there’s little cause to sing it right now.

Here’s a much simpler and more direct explanation of what’s going on in the economy: oil and energy prices have been on the rise. There is a very close correlation between rising energy prices and the spiking rates we see in the 10-year note. It happens all the time. Crude oil has moved from $17 a barrel to $26 a barrel. And Treasury rates have moved up in lock-step.

This sets up an interesting investment strategy. If oil prices fall in the months ahead, then the 10-year rate is going to retrace back toward 5%. And this means stocks will have greater value, especially with today’s GDP report that shows an unexpectedly strong 17.9% (non-annualized) rise in profits.

The key is whether energy prices will fall, and ace oil analyst Fred Leuffer thinks they will.

Leuffer, the Bear Stearns expert, believes the Saudis want a price of $20 a barrel in order to avoid choking off the world economic recovery — and especially the U.S. recovery. He believes this price will include a $1 or $2 risk premium that covers the threat of a U.S. invasion of Iraq. Consider this: If the global economy declines, the Saudis and OPEC will be in a serious over-production position by spring that will cost them a further loss of market share. The Saudis simply need to get the crude price down.

Mr. Leuffer also notes that oil production in Russia and Norway was never cut, Mexican capacity and production are on the rise, and Angola production is also increasing. So non-OPEC world market share will continue to grow at the expense of the Saudi-OPEC business unless prices move back toward $20 per barrel.

Obviously, this would be a good turn for both interest rates and stock prices.

That said, U.S. economic growth could slow a bit in the spring quarter as a result of the latest increases in energy prices. Gasoline prices at the pump, for example, have increased to $1.30 from just above $1.00. The economic rule of thumb is that 10-cent a gallon increases cost motorists $13 billion annually. So the arithmetic implies that the economy will lose $40 billion in purchasing power.

This does not suggest that the economic recovery will be dashed, but it does infer that a roaring 5% to 6% growth rate in the spring and summer quarters is not likely. Given the way the Fed and the bond market often view the world, this also means the chance of rapid-fire Fed interest rate hikes is far lower than market gurus believe.

By the way, Mr. Fred Leuffer is the rare analyst who is unafraid to remove stocks from his recommended list. Because he believes in his own $20-a-barrel projection, he has lifted all but two oil companies from his buy column. Good man, Mr. Leuffer. Honesty is a virtue. And being smart about oil also helps quite a bit.

Larry Kudlow is the author of JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.

Most Popular

World

Europe Makes Its Choice

The president of the European Council does not usually make news when addressing the UN General Assembly. In fact, the current occupant of the post, Charles Michel might be used to giving UN addresses that attract minimal attention. He is, after all, a former prime minister of Belgium. However, today was ... Read More
World

Europe Makes Its Choice

The president of the European Council does not usually make news when addressing the UN General Assembly. In fact, the current occupant of the post, Charles Michel might be used to giving UN addresses that attract minimal attention. He is, after all, a former prime minister of Belgium. However, today was ... Read More
Law & the Courts

Judge Barrett on the Second Amendment

Judge Amy Coney Barrett’s impressive dissent in Kanter v. Barr (pp. 27-64) illustrates both her fidelity to the Supreme Court’s landmark Second Amendment ruling in District of Columbia v. Heller (2008) and her masterful application of the constitutional methodology of originalism. Rickey I. Kanter pleaded ... Read More
Law & the Courts

Judge Barrett on the Second Amendment

Judge Amy Coney Barrett’s impressive dissent in Kanter v. Barr (pp. 27-64) illustrates both her fidelity to the Supreme Court’s landmark Second Amendment ruling in District of Columbia v. Heller (2008) and her masterful application of the constitutional methodology of originalism. Rickey I. Kanter pleaded ... Read More

BLM Becomes the PLO

I am inclined to think that the Palestinians have some legitimate beefs, historically speaking. I just don’t care very much. You blow up children in pizza shops, and your priorities go right to the bottom of my global humanitarian to-do list. Palestinians want a state? I wouldn’t lend Mahmoud Abbas a cup ... Read More

BLM Becomes the PLO

I am inclined to think that the Palestinians have some legitimate beefs, historically speaking. I just don’t care very much. You blow up children in pizza shops, and your priorities go right to the bottom of my global humanitarian to-do list. Palestinians want a state? I wouldn’t lend Mahmoud Abbas a cup ... Read More
Law & the Courts

The Judicial Branch Ragnarök Is Upon Us

As expected, President Trump selected Amy Coney Barrett as his third nominee to the U.S. Supreme Court, and now the Judicial Branch Ragnarök and Related Festival of Catholic-Bashing is upon us. Senate Democrats could argue that based upon Barrett’s past decisions, they don’t agree with her legal ... Read More
Law & the Courts

The Judicial Branch Ragnarök Is Upon Us

As expected, President Trump selected Amy Coney Barrett as his third nominee to the U.S. Supreme Court, and now the Judicial Branch Ragnarök and Related Festival of Catholic-Bashing is upon us. Senate Democrats could argue that based upon Barrett’s past decisions, they don’t agree with her legal ... Read More
Law & the Courts

On Judge Barrett, Let’s Tell the Truth

Once when I was a kid, my dad held up three fingers and asked, “Does this two look like a three?” Little did I know that this attempted sleight of hand would become a regular feature of the process for appointing federal judges. Watch for it in the days ahead as the Senate considers President Donald Trump’s ... Read More
Law & the Courts

On Judge Barrett, Let’s Tell the Truth

Once when I was a kid, my dad held up three fingers and asked, “Does this two look like a three?” Little did I know that this attempted sleight of hand would become a regular feature of the process for appointing federal judges. Watch for it in the days ahead as the Senate considers President Donald Trump’s ... Read More