Oil and Interest Rates

Long term interest rates are back below 4.0%. Is this a good thing? Not necessarily. Because low rates may simply reflect worries that the economy is slumping, largely because of the high price of oil.

In fact, oil prices and long-term interest rates do indeed seem to be moving in opposite directions lately. The chart below shows both series since July 1.

The correlation coefficient for these two series is -.77. The most plausible explanation is that the bond market is indeed worried that higher oil prices will noticeably dampen economic growth. Despite what Alan Greenspan says.


Update: Now that I look more closely at the data, it’s apparent that the negative relationship between oil prices and interest rates has grown stronger in recent weeks. Here’s a graph of the same series for just the month of October.

I don’t see any other plausible interpretation than that the bond market is reacting directly to the price of oil. Which means that they are convinced that high oil prices will substantially harm economic growth.