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– September 15, 2015
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Monetary
All eyes focus on the FOMC September meeting
In the monetary policy landscape this month, market participants paid close attention to the possible interest rate liftoff that could come out of the Sept. 16-17 meeting of the policy-making Federal Open Market Committee (FOMC). The Fed has long telegraphed intentions to raise interest rates at the end of this year, most likely this month. But the recent market turmoil called these plans into question. The FOMC’s decision likely will depend on how Fed officials weigh long-term growth trends against short-term market fluctuations.

In a longer-term perspective, a number of economic indicators provide reasons to raise interest rates sooner rather than later. The labor market has substantially improved from the bleak days of 2009. By July of this year, the unemployment rate had fallen to 5.3 percent from 10 percent in October 2009. Even though inflation has stayed below the Fed’s 2 percent target, some believe that the low unemployment rate will lead to higher prices in the near future. Additionally, the $2.5 trillion excess reserves sitting in the banking system are creating what some analysts see as a future threat of runaway inflation.

On the other hand, recent global turmoil has raised some concern about its spillover to the U.S. economy in the form of reduced growth. The Chinese currency’s sudden devaluation in the middle of August, for instance, caused large swings in U.S. stock markets. The Dow Jones Industrial Average fell about 10 percent within a week. In such an environment of short-term market upheaval, a hike in rates could magnify capital market distortions and harm the U.S. economy.

Despite the recent market fluctuations, the U.S. economy has grown steadily and gained momentum. Given the Fed’s longstanding signals that an interest rate increase will come by the end of this year, if it doesn’t take an action this month, we expect to see a move in either October or December.

Regulatory
Global events may lead to lifting the ban on exporting crude oil
Moves are afoot in Congress to lift a 1975 ban on exports of U.S. crude oil. The law applies to most crude exports but not refined products such as gasoline. Market and political changes seem to be pushing lawmakers closer to ending the policy. In July, the Senate Energy Committee passed a bill that would remove the ban, making full Senate consideration a possibility.

Upsetting the status quo would result in winners and losers, pitting oil refiners against oil producers. Producers would like to see the ban lifted because there is a mismatch between what comes out of the ground in the U.S. and what domestic refiners can process. Most U.S. refineries are geared to handle heavy crude, mostly imported from the Middle East. Domestic crude is typically a lighter grade, which processors can refine but only at a higher cost. Consequently, large inventories of domestic oil are keeping U.S. crude prices (measured by the West Texas Intermediate [WTI] benchmark), considerably below the global price (measured by the Brent benchmark; see Chart 4), even as U.S. refineries have operated at more than 90 percent of capacity for over a year.

The price gap between U.S. and global supplies emerged in 2011 with the rapid increase in U.S. crude production, up over 60 percent since then. Unable to export, U.S. oil producers have to store or sell their output to domestic refiners at a discount, which at times has reached as high as $20 per barrel. This situation has boosted the appeal of lifting the ban.

The argument in favor of lifting the export ban goes beyond helping domestic oil producers. Allowing crude exports could prompt more investment, spurring employment and growth. The fear one might have that exports could lead to higher gasoline prices at the pump is unfounded. Since gasoline can be exported, its price depends on the global oil benchmark, not the domestic one. For this reason, allowing crude exports might even bring U.S. pump prices down, as the flow of U.S. supplies into the global market could lower the world benchmark.

The objections to ending the export ban stem mostly from unrelated considerations, such as the added strain on the environment from increased crude oil production, including the use of hydraulic fracturing extraction techniques. Of course, U.S. refiners, who currently benefit from depressed domestic crude prices, prefer to keep the ban.

Recently, calls for ending the policy have gotten stronger. The slowdown in China, the world’s second-largest consumer of petroleum, has pushed down global prices. From a recent peak in May 2015 to the end of August, Brent crude fell over 30 percent. Compared with a year ago, it was down about 60 percent. With domestic prices trailing the Brent benchmark, U.S. producers are feeling the squeeze.

Not only oil industry experts but also research organizations such as the Brookings Institution say lifting the export ban would help the U.S. economy. This position was echoed in a July report by the Government Accountability Office, the investigative arm of Congress. It concluded that ending the policy would raise U.S. crude prices, stimulating investment, spurring production, and lowering pump prices.

Whether Congress will act on the Senate bill and how President Barack Obama’s administration would react to its passage remains uncertain, but we have come closer than ever to the possibility that the 40-year-old policy may end.

Next/Previous Section:

1. Overview
2. Economy
3. Inflation
4. Policy
5. Investing
6. Pulling It All Together/Appendix


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