Investors -- certainly U.S. stock investors -- would be wise to keep one eye on the goings-on in Washington between congressional Democrats, Republicans and President Barack Obama, and one eye on the price of oil, West Texas Intermediate of which Friday closed down 22 cents to $102.81 per barrel.
The reason? A downgrade of the U.S. government’s credit rating – let alone a market- and economy-jarring debt default – would likely lead to a weaker dollar, higher oil prices and yet another rise in already sky-high gasoline prices. Oil, priced in dollars, tends to move higher as the U.S. dollar falls, and vice-versa. It’s a result of oil traders trying to maintain their “purchasing power” in the event of a weaker dollar
What’s more, if Democrats and Republicans can’t reach a debt deal and the U.S. government defaults on its debt in about three weeks – a far worse scenario than a credit downgrade - the dollar may decline substantially, boosting oil’s price even more, perhaps above $130 per barrel for West Texas Intermediate crude.
So far in the financial crisis era, the dollar has held its own versus the euro, trading at $1.35, at $1.60 versus the British pound, and at 98.24 versus Japan’s yen, although Japan’s monetary easing in 2013 has been a major factor in supporting the buck versus that major currency.
However, if the U.S. Treasury has to postpone certain payments in three weeks because it legally can not borrow money because the debt ceiling isn’t raised, investors would likely drive the dollar lower against the world’s other, major currencies, and in the process send oil prices much higher.
How low could the dollar go? Different stress tests real different weaker-dollar scenarios. What’s important is that a 10% decline in the dollar would probably push oil above $120.
Oil: Approaching The 'Danger Zone'
Further, the reason why one should keep an eye on oil is obvious enough: oil is in "the danger zone," from a U.S. GDP growth standpoint.
No one knows precisely at what point oil begins to substantially hinder consumer spending and slow commercial activity – but this much is known: every $1 per barrel rise in oil decreases U.S. GDP by about $100 billion per year and every 1 cent increase in gasoline decreases U.S. consumer disposable income by about $600 million per year.
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