Oil Lights the Fire, Bonds Send the Bill – and the Fed Reaches for the Extinguisher
This post was originally published on jpfs.com
I was hoping the markets might start behaving themselves. Fat chance. They appear to have spent the week drinking crude oil, frightening the bond market and arguing over whether artificial intelligence will save humanity or make most of it redundant before lunchtime.
The main source of trouble remains the Middle East. Attacks on Saudi energy infrastructure forced the closure of the vital East–West pipeline, which normally allows Saudi Arabia to move oil to the Red Sea without relying entirely on the Strait of Hormuz.
With one escape route damaged and the other surrounded by warships, missiles and angry men making threats from behind large desks, Brent crude climbed above $107 a barrel.
Oil eased by around 2% on Wednesday after Saudi Arabia offered Asian customers additional supplies routed through Oman. US inventories also rose unexpectedly, with crude stocks reportedly increasing by 7.1 million barrels. Brent slipped towards $107 and WTI traded near $103.
Before anyone starts celebrating, however, this is still extremely expensive oil. The immediate panic may have eased, but the underlying supply problem hasn’t disappeared. Saudi Arabia has found a detour, not performed a miracle.
Naturally, expensive energy has revived inflation just as central bankers were preparing to declare victory, congratulate themselves and disappear onto the conference circuit.
US consumer prices rose 0.4% in August, while core inflation increased by 0.3%. Add oil above $100 and a stubbornly resilient American economy, and markets are now convinced that the Federal Reserve will raise interest rates by 25 basis points this evening, taking the federal-funds range to 3.75%–4.00%.
The quarter-point rise is already priced in. What matters is what Fed Chairman Kevin Warsh says afterwards – and, more importantly, how badly the bond market chooses to misunderstand him.
One rise accompanied by soothing noises may calm investors. One rise followed by a warning that several more are coming could put another boot through the equity market’s front door.
The bond market has already delivered its verdict. The US ten-year Treasury yield briefly moved above 5%, its highest since 2007, while German Bund yields approached 17-year highs.
Governments that spent the past decade borrowing as though money was free have discovered that the lender would like it back. With interest.
Equity markets struggled through most of last week before staging a respectable rally on Friday. The S&P 500, Nasdaq and Dow each gained approximately 1% on the day, although all three still finished the week lower. Since then, higher yields, the oil shock and concerns over AI investment have kept investors nervous.
Technology shares were hit particularly hard after leading figures in artificial intelligence suggested that development might need to slow. Apparently, investors are perfectly comfortable with machines becoming more intelligent than human beings. What terrifies them is the suggestion that companies might spend slightly less money building them.
Chipmakers, including NVIDIA, came under pressure, while software and cybersecurity companies attracted buyers. To me, this looks more like a rotation within technology than the death of the AI boom.
But let’s be honest: current valuations already assume that nearly every expensive promise comes true. When a share price requires unlimited growth, unlimited spending and unlimited enthusiasm, even a modest dose of reality can behave like a laxative.
The FTSE 100 recovered slightly on Wednesday as oil prices retreated, but it remains close to two-month lows after suffering its steepest weekly decline since late July.
Higher energy prices may help BP and Shell, but they also increase costs for almost every other company in Britain. The FTSE 250 has performed even worse because domestically focused businesses must contend with weak growth, expensive borrowing and a government that appears to regard economic confidence as an unnecessary luxury.
The European Central Bank has already raised its deposit rate by 25 basis points to 2.5%, warning that energy-driven inflation could persist. Nevertheless, EUR/USD remains weak, trading around $1.1550 and not far above Monday’s one-month low near $1.1520.
The dollar has benefited from higher Treasury yields and expectations of further Fed tightening. Europe, meanwhile, is being punished twice: higher oil raises inflation while damaging growth.
The ECB can raise interest rates, publish reports and hold emergency meetings, but it cannot print energy – and Lord knows it has tried printing almost everything else.
Bitcoin has slipped towards $75,500, extending its weekly decline and trading near a four-week low. The US Senate’s failure to advance major cryptocurrency legislation added to the weakness, while higher bond yields reduced demand for speculative assets.
Bitcoin enthusiasts still describe it as digital gold. At present, it’s behaving more like a technology share wearing a leather jacket.
That doesn’t destroy the longer-term argument, but a sustained break below $75,000 would leave the market vulnerable to another leg lower. Bitcoin may eventually replace the financial system, but this week it appears to be waiting nervously for permission from the Federal Reserve.
Gold, meanwhile, recovered strongly on Wednesday, rising more than 1% to approximately $4,346 an ounce as the dollar softened and oil retreated. Silver gained around 1.4%, while platinum and palladium also moved higher.
Gold remains caught between geopolitical danger and rising interest rates. Fear encourages investors to buy it, while bond yields above 5% encourage them to demand an income. Considering the circumstances, gold is holding up reasonably well.
Elsewhere, industrial metals and agricultural commodities remain mixed. High energy and transport costs are supportive, but the stronger dollar and doubts over global growth are limiting enthusiasm.
This is no longer a market in which every commodity rises together. Traders need to examine individual supply chains rather than simply buying anything that can be dug up, drilled or fed to a cow.
For this afternoon, everything revolves around the Fed. I’ll be watching the US ten-year yield around 5%, Brent near $105–$107, EUR/USD around $1.1520 and Bitcoin at $75,000.
If yields resume climbing after the announcement, richly valued technology shares could face another uncomfortable session. If Warsh sounds less aggressive than expected, we may get another relief rally – although relief rallies have an unfortunate habit of relieving inexperienced traders of their money.
After so many years in this business, I’ve learned keeping your powder dry is considerably cheaper than setting fire to it simply because a central banker has wandered towards a microphone.
Please note the political opinions expressed above are those of the author himself, and do not necessarily reflect the opinions of JP Fund Services AS.
The post Oil Lights the Fire, Bonds Send the Bill – and the Fed Reaches for the Extinguisher first appeared on JP Fund Services.
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