Mortgage rates are holding near 5.75 percent (30-year, fixed-rate, “conforming” amount with the lowest fees), and the financial market dynamic is straightforward: as oil goes up, then stocks, the economy, and rates go down.

Mortgage rates are holding near 5.75 percent (30-year, fixed-rate, “conforming” amount with the lowest fees), and the financial market dynamic is straightforward: as oil goes up, then stocks, the economy, and rates go down.

Federal Reserve Chairman Alan Greenspan’s transient “soft patch” is muddier and wider than he insisted a month ago. CPI actually fell .1 percent last month (in a stable-price environment, as the energy component of total prices rises, the aggregate of others must fall – painful for business), industrial capacity in use is tailing, and everybody’s leading indicators are going flat. The exception is housing, still very strong.

There are limits to oil as a benefit to interest rates. At any moment, high and rising prices for energy can percolate into the general price structure; that brew would bring higher rates from the Fed and a deeper economic slowdown – a classic stagflation.

On the other side of the trade, there is a strong likelihood that oil is approaching the top end of a new trading range and may soon fall back below $40/bbl. At some level near $50/bbl, demand will begin to contract – either by cumulative conservation by consumers, priced out of their habits, or by economies tipped wholesale into slowdown or recession.

In the 1970s, faith-based energy policy held that demand was inelastic to price; that is, we were so hooked on petro-juice that the price could go to infinity and our consumption would continue unabated. Another article of faith: the recoverable supply of oil was finite. No matter how high prices went, there would never be any greater supply of petro-energy.

This fixed-demand, fixed-supply holy writ encouraged many to calculate (much as Bishop Ussher’s count in 1654 of the succession of generations in scripture led him to the certain date of Creation in 4004 BC) the year, or at least the decade in which the world would run out of oil.

You’ll still hear this figuring in deep-green circles, but the petro market has not worked out that way so far, and will not. As price rises, demand falls and new supply is found. However, like a fault line in the earth’s crust, the equation doesn’t balance smoothly; it accumulates strain and releases suddenly. Demand grows easily and directly with purchasing power, leading to a price earthquake before supply responds. Supply is sticky in two ways: lead time and price suspicion. It takes years and years to deploy new capital, and oilies are very reluctant to begin to deploy until they think they know the bottom of the price range for oil in coming decades.

There are lots of enhanced recovery methods, and alternate energy sources and technologies available if investors have confidence that oil will not fall below $35/bbl. There are, however, a great many investors who had their eyebrows blown off in the energy-market lab when they bet on durable $33/bbl oil in 1980 (about $80 today), only to see oil fall to $9 in 1986 (about $18 today). Thus, supply will lag.

Much as I love the idea of U.S. independence from imported oil, any dramatic effort to cut our consumption (whether for independence, the environment, or climate) will be a boon to our economic competitors, who would eagerly sop up (and burn) the newly excess (and cheap!) supply.

At the end of this cycle, just as real estate developers have a proclivity for building 10 office buildings to satisfy demand for two, at some point in the decade ahead, price-enhanced supply will begin to pursue retreating demand.

When the current straight-line increase in oil breaks and falls, the Fed will have to lean into the resulting economic stimulus. But, for now it looks as though the Fed is going to have to cool it after another one or two .25 percent hikes, those having little or no impact on mortgages.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.

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