- Crude begins three-day grind towards U.S. rate decision for July
- Fed chief Jay Powell likely to laud win against inflation but express caution too
- Dollar’s performance post-Fed will be key to deciding if oil rally steams on
The three-day comatose mode for markets ahead of the Federal Reserve’s rate decision is on, with oil prices barely moving Monday amid debate on what the central bank would say about — rather than immediately do — with rates when it meets Wednesday.
Since the Fed skipped a rate increase in June for the first time since March 2022, speculation has been rife that this week’s meeting will produce the final hike for this year — despite projections showing there could be another before its final policy meeting on Dec. 13.
The Fed’s use of the most aggressive rate hikes in four decades to clamp down on inflation has produced excruciatingly slow results that have just started to yield after 16 months. Indeed, if the central bank stops with just one hike on Wednesday, risk-on appetite could flourish from traders expecting the next big thing: rate cuts. In such an environment, oil prices could spike, hurting growth and rolling back hard-won gains against inflation.
New York-based West Texas Intermediate, or WTI, was down 55 cents, or 0.7%, to $76.52 per barrel by 03:15 ET (07:15 GMT) Monday.
London-based Brent for September delivery also slid 55 cents, or 0.7%, to $80.33 per barrel.
Still, CMC Markets analyst Leon Li said he expects U.S. crude prices to eventually reach $80 a barrel again on a "seasonal demand rebound".
Analysts at National Australian Bank had a somewhat similar view, saying:
"While another Fed rate hike this week may drive some short-term price volatility, we expect tightening market conditions on OPEC's supply cuts and increasing market speculation of further stimulus in China to continue to push prices higher through 3Q23.”
Those bullish thoughts run contrary to the slashing of near-term price forecasts on crude by almost every major Wall Street bank over the past two months.
The dreary performance expected in oil until Wednesday — with potentially downside action, rather than upside — is also an interesting dichotomy to the so-called strength in oil, which might not be that strong after all without the easy money typically provided by the Fed over the years.
For July thus far, crude prices are up 9% after non-stop rhetoric from the Saudis and their allies that they are cutting production. United Arab Emirates Energy Minister Suhail al-Mazrouei said on Friday that actions by OPEC+ to support the oil market are sufficient for now and the group is "only a phone call away" if any further steps are needed. Also Last week, U.S. energy firms made their deepest oil rig cut since early June, with operating units down by seven to 530.
Yet, non-friendly messaging from Fed Chair Jay Powell this week on the direction for rates could bring a hard stop to the rally, particularly if stimulus efforts by China fail to provide the spark needed for investors to buy back into the growth story of the world’s largest oil importer.
On the positive side, economists are already feeling hopeful about the United States dodging a downturn. Inflation cooled in June, while joblessness in the month fell. Those two factors normally have an inverse relationship.
And while labor market growth for the month was the slowest since the coronavirus pandemic ended, employers still created enough jobs to meet the expansion in population— and hiring is still faster than in the pre-outbreak era in 2019.
Beyond the Fed, focus this week is also on the European Central Bank and the Bank of Japan. The ECB is widely expected to hike interest rates by 25 basis points on Thursday, although the European bank recently signaled that an end to its rate hike cycle is close. In Canada, meanwhile, inflation dropped to within the control range of the Bank of Canada for the first time since March 2021.
Falling global bond yields were also prodding investors to move out of Treasuries and into better potential havens like gold as well as true risk assets such as oil and equities, said analysts.
And just as important as the Fed’s actions and thoughts is the dollar, which tumbled to 15-month lows, turbo-charging oil’s 9% rally of the past four weeks, before rebounding just ahead of the Fed meeting.
Thus, attention next week will be on not just what the Fed does but also says, given Chairman Jay Powell’s stance at his June news conference that the central bank might be in a position to do two more rate hikes before the year is out.
If Powell says — or even remotely suggests — that the Fed is done for this year with hikes, oil could have a better shot at turning $80 a barrel into support rather than resistance.
A definitive end to U.S. rate hikes could also prod gold out of its $1,900 slumber and put it back on the race towards $2,000 an ounce.
Powell May Not Say What Markets Want to Hear
But knowing Powell, he will likely say the Fed is heartened at the progress it has made in slowing inflation — which, according to the CPI, grew by just 3% per annum in June versus the 40-year high of 9.1% a year ago. While taking a victory lap, the Fed chair will probably add that he was leaving the door open to another hike should inflation spike again.
And Powell may have good reason for keeping the Fed tool kit on inflation open.
Borrowing costs on loans such as the 30-year fixed-rate mortgage and home equity lines of credit are now the highest in more than two decades, creating affordability challenges and tightening the flow of credit to households, Sarah Foster noted in a blog on Bankrate.com.
“But there have also been some silver-linings: Yields at the nation’s top savings accounts are the highest in 15 years,” she added.
The process of unwinding inflation in the more-stubborn services, housing, medical care, and insurance categories could take more time, and Fed officials likely aren’t yet satisfied with how high core price increases currently are. Economists say the Fed will likely want to keep its options open.
Inflation could also worsen if officials give the all-clear that they’re done, partially because it could spark a loosening in financial conditions that unwinds some of the necessary tightening in borrowing costs. Oil bulls are already drooling at the prospects of $90 pricing or above for crude if summer demand spikes and the Saudis and other producers in OPEC double down with output cuts.
Almost everyone now is clamoring for the Fed to step aside from the rate hike lever. On Wall Street, the celebratory mood is evident with the end nigh to almost a year and a half of rate hikes. It will be advisable for the central bank to proceed with caution. There will be no applause for the Fed if it gives the all-clear now on rates and reverses course because of a recession.
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Disclaimer: The content of this article is purely to educate and inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.