As somebody whose start in markets came in interbank foreign exchange, I am used to a degree of obsession with central banks. Back when I started in that market, which was longer ago than I care to admit, central banks still believed that they controlled the fate of their own currencies. They seemed to take delight at that time in surprising us all, whether that be with interest rate changes or direct intervention, and we all spent an inordinate amount of time parsing everything they said and trying to predict what they would do. That said, though, I have never seen global markets quite as obsessed with one central bank as they are now with the Fed.
Every market, from stocks to bonds to commodities to crypto, seems to be reacting to things based on how they might influence the Fed’s decisions, and every trader is giving a massive amount of weight to the words of a man who told us that inflation was “transient”, then “sticky”, and whose view of the situation seems to change every time he opens his mouth. That is not a criticism of Jay Powell, no matter how much it may read as one. He has, on each occasion, called it as he saw it, which is an admirable thing. However, the fact is that economic conditions change. I would rather have someone in charge who understands that than someone who sticks to an outdated view, but to base long-term trading and investing decisions on how he currently views things makes very little sense.
Still, that is where we are, so even those…
As somebody whose start in markets came in interbank foreign exchange, I am used to a degree of obsession with central banks. Back when I started in that market, which was longer ago than I care to admit, central banks still believed that they controlled the fate of their own currencies. They seemed to take delight at that time in surprising us all, whether that be with interest rate changes or direct intervention, and we all spent an inordinate amount of time parsing everything they said and trying to predict what they would do. That said, though, I have never seen global markets quite as obsessed with one central bank as they are now with the Fed.
Every market, from stocks to bonds to commodities to crypto, seems to be reacting to things based on how they might influence the Fed’s decisions, and every trader is giving a massive amount of weight to the words of a man who told us that inflation was “transient”, then “sticky”, and whose view of the situation seems to change every time he opens his mouth. That is not a criticism of Jay Powell, no matter how much it may read as one. He has, on each occasion, called it as he saw it, which is an admirable thing. However, the fact is that economic conditions change. I would rather have someone in charge who understands that than someone who sticks to an outdated view, but to base long-term trading and investing decisions on how he currently views things makes very little sense.
Still, that is where we are, so even those of us who focus on trading in the globalized, real world of energy have to pay attention. The question must therefore be asked: what can we read into the Fed’s intentions after this week’s inflation numbers?
Lest you missed it, the two major data points around US inflation for March, the Consumer Price Index (CPI) and Producer Price Index (PPI), were released this week. Somewhat fittingly given the current mood of markets, they sent conflicting messages. CPI came first, on Wednesday morning. The numbers showed a third consecutive increase in the inflation rate and a second consecutive miss of expectations, prompting bond rates to move higher and stocks to drop dramatically. Then, on Thursday morning, the more forward-looking PPI indicated that the slight resurgence in inflation that we have seen in the first quarter may be over, and markets moved in the opposite directions.
The most remarkable thing about this bout of intense Fed watching is that the more information we get, it seems, the less we know. Just three months ago, the bond market was pricing in six or seven rate cuts this year. That number is now down to two, with a growing feeling on Wall Street that there may be only one, or none at all. And yet US stocks are doing just fine. The jobs market remains tight, and the economy continues to grow, so it has become clear that a 5.0 to 5.25% target rate for Fed Funds is not strangling economic activity. What felt like a disastrous outlook a few months ago, higher for longer, is now seen by traders and investors as being quite normal and acceptable.
Jay Powell and the other FOMC members know this, of course, and it has made a conservative path, with cuts delayed at least until the second half of this year, a lot less risky in terms of the market reaction. If there is one thing I know after forty years of watching central banks, it is that central bankers usually don’t need too much persuading to take the conservative approach, so a further delay to cuts looks likely.
So, what does all this mean for energy investors?
Well, interestingly, although I said that all markets have been obsessed with the Fed, there has been one notable exception. Oil has done its own thing over the last month or so, even climbing on Wednesday after the CPI print that suggested inflation was still a problem. That is because oil traders are focused on supply issues right now, and supply is tight. That can continue for a while, as I wrote last week, but if the Fed does delay cutting rates beyond their June meeting, all traders, even oil traders, will start to fret about the impact of that on global growth.
So, while I am still bullish on oil and therefore on oil stocks, I can see a time coming before too long when things turn around. To get an idea of when that might be, we should all be keeping an eye on US economic data and how it might impact the Fed. To put it another way, like it or not, we all need to be Fed watchers right now.
