Global markets feeling oil slump

Oversupply of oil through US fracking and no let-up in Middle East output are driving prices down. Photo / NZME

Exceptionally low oil prices have thrown world financial markets a curve ball by driving bond yields sharply lower and undermining share prices.

Major sharemarkets, particularly those with exposure to the energy sector, weakened and bond yields continued their march lower as oil prices under US$50 a barrel added more weight to already considerable deflationary pressures.

On Wall St, the Dow Jones Industrial Average dropped by 1.8 per cent, or 96.5 points, to 5333 after oil prices dropped to five-and-a-half year lows.

Closer to home, Australian stocks - led by declines in energy companies - weakened, with the All Ordinaries Index dropping by 83 points, or 1.53 per cent, at 5346. In Britain and Europe, benchmark share indices dropped by around 2 per cent each on the back of lower oil prices and their likely deflationary effects, coupled with worries about poorer growth prospects in Europe.

The New Zealand sharemarket, which has a relatively light exposure to oil sector stocks, weakened - the NZX 50 dropping by 41 points (0.7 per cent) to 5561.

Increased US oil production, coupled with Opec's decision to not reduce production, has created an oversupply, which has driven oil prices down by 50 per cent since June.

Lower oil prices have already been making their presence felt in the inflation-sensitive bond markets.

In the past five business days, benchmark New Zealand 10-year government bond yields have fallen from 3.72 per cent to 3.57 per cent, and by about 50 basis points since mid-November.

"Caution is creeping in across the investment community, driven by low oil prices and lower inflation inputs from that," said Shane Solly, portfolio manager and research analyst at Harbour Asset Management.

"This is an unusual time, with oil prices hitting 50 bucks for the first time in five and a half years, and there are people talking of it going close to US$40 before it goes back up again," he said. "It is changing the economic and pricing dynamic quite a lot."

In the United States, 30-year US government bond yields hit their lowest point in more than two years. The difference between yields on US two-year notes and 30-year bonds narrowed to the lowest point since January 2009, when oil prices dropped below US$50 a barrel.

"The factors that kept Treasury yields low in 2014 will continue to be the major determinants of yields in 2015," Gary Pollack, at Deutsche Bank AG's Private Wealth Management unit in New York, told Bloomberg. "Lower oil obviously means lower inflationary pressures with the fear of deflation overhanging the market - another positive for bonds."