Oil, Price of and Its' Impact on
Mortgage Rates

Q. As an occasional reader of your newsletter, I notice that you sometimes list an increase or decrease in the price of oil. It escapes me as to what the price of oil has to do with the interest rates on mortgages.

A. It's a fair question and one that not many readers would have the courage to ask. The short answer is that there are a number of variables that affect the nation's economy and by extension the interest rates on home mortgages.

In my Month In Review, a feature that opens all newsletters, I include what I think are the most salient news stories of the day and/or week which is followed by the Rate Summary which allows readers to draw their own conclusions as to which events (or combination of events) in the preceding month impacted mortgage rates.

The longer answer (and I hope it's worth the trip) is that macroeconomics is an inexact science. In the economic scheme of things there are a multitude of intersecting variables that comprise GDP, like employment, productivity, wholesale prices, sales of goods and services, balance of trade, transfer payments (social security, Medicare, unemployment insurance), foreign affairs (wars) and inflation to name just a few. To fathom the extent of how disparate pieces of a nation's economy impact one another is a little like trying to assess how raindrops and their resultant intersecting ripples affect the ebb and flow of interest rates. Nevertheless, it is possible to see the relative cause and effect between certain events and detect an idea as to where and how the economy is headed from deciphering some of the connections between the various components. Our economy is consumer driven: consumer spending accounts for two-thirds of gross domestic product or the American economy. At present, the economy remains weak; one in 6 Americans can't find enough work. Not surprisingly, rising oil prices cut into family budgets. The price of a gallon of gas is near $2.63 according to the latest AAA survey. That's well below the 2008 peak of $4.11 but up 25% from a year ago and 63% above 2008's December low.

What's more, the factors behind this spike seem likely to persist for the foreseeable future. They include a pickup in global economic activity fueled by massive government spending, a decline in the purchasing power of the dollar as the U.S. holds interest rates near zero [oil prices are denominated in dollars], and lack of new oil supplies coming on line to meet future demand. While these trends hardly ensure rising fuel prices, they seem to have been doing their part so far, putting gasoline at $3 a gallon in much of the U.S.

Any time it gets above $3, you start to see a change as budgets get squeezed. A price of $3 a gallon is noteworthy because it's around the level at which consumers are devoting 6% of their budgets to energy costs. Hitting that point in recent years seems to have prompted American to pull back. As energy prices soared and incomes came under pressure, Americans first stopped buying pickup trucks and then deserted the local car dealer altogether. Car sales plunged in the spring of 2008 before falling off a cliff with the collapse of Lehman Brothers that September.

The price of oil played a bigger factor in the recession than people seem to remember. U.S, oil consumption has slid 9% since 2007 and Americans drove 3% fewer miles in the latest year through August than they did two years earlier. Every recession since 1972 has been associated with an oil price surge that took U.S. oil consumption past 4% of gross domestic product. Energy prices don't need to rise that much before a fragile consumer-led economy could face another setback. A run-up in the cost of oil squeezes consumers which could complicate the economic recovery.

As people consume fewer goods and services there are fewer sales and fewer sales mean less need for new hires. Because of job loss 14% of homeowners are currently delinquent or in the foreclosure process. Rising foreclosures and delinquencies mean a drop in the price of homes. As home prices drop, interest rates fall (usually). Thus, achieving energy independence can reduce the economic pangs associated with higher oil prices.

Copyright 2020 Rod Haase.  All rights reserved.