Oil-production cuts could force Fed to raise interest rates even higher to fight inflation
A surprise production cut by Saudi Arabia and several of its OPEC+ partners could complicate the outlook for stocks, bonds and currencies while undercutting the fight against inflation by the Federal Reserve and other central banks, analysts said.
Of course, some analysts expect it could ultimately have the opposite effect by helping to quicken the global economy’s slide into recession. In this scenario, the economic blowback from any oil-price shock would be similar to the credit crunch resulting from the collapse of Silicon Valley Bank that Federal Reserve President Jerome Powell highlighted during a press conference last month.
To recap: on Sunday, Saudi Arabia’s Ministry of Energy and a handful of OPEC+ members announced they would cut production by a combined 1.16 million barrels a day starting in May and lasting through the end of the year.
The Kingdom led the way with a planned cut of 500,000 barrels per day, with Iraq, Oman, Kazakhstan, the United Arab Emirates, Kuwait and Algeria making up the rest. On top of this, Russia said it would extend its own voluntary production cut of half-a-million barrels per day through the end of the year. It had been due to expire at the end of June.
At first brush, the cut appears timed to coincide with the pre-summer increase in oil refinery production as producers and refiners prepare for the busy summer travel season in North America, said Jorge Leon, senior vice president of oil markets research at Rystad Energy, in a note to clients.
The cartel has been using production cuts in an effort to bolster prices for months now, much to the consternation of the Biden administration. This latest move comes on top of a 2 million-barrels-per-day cut announced back in October, the largest cut by the cartel since the advent of the COVID-19 pandemic back in 2020.
However, the October move offered little lasting support for oil prices, with crude drifting lower into year-end and then extending its decline in the first quarter of 2023.
Oil traders caught off guard
Oil futures shot higher Sunday evening, following the announcement of the cut earlier in the day. West Texas Intermediate crude futures, the U.S. benchmark, initially surged 8% to touch their highest level since late January before moderating.
WTI crude for May delivery
CL00
was up 6% in recent trade at $80.24 a barrel on the New York Mercantile Exchange. June Brent crude
BRN00
BRNM23
,
the global benchmark, gained 6.1% to $84.78 a barrel on ICE Futures Europe.
Bianco Research President Jim Bianco said in a tweet that the production cut caught oil traders off guard.
He noted that net long-oil positions by large speculators had fallen to their lowest levels since 2011, according to weekly data released by the CFTC, as commodity trading advisers — a classification of funds who typically pursue trend-following strategies in futures markets — had increased their short positions since the start of 2023.
Higher oil prices bolstered energy stocks, which have underperformed since the start of 2023. They helped offset losses in other areas of the market, as seven of the 11 S&P 500 sectors traded lower, with the tech-heavy consumer discretionary and information technology sectors seeing the biggest declines, according to FactSet. Meanwhile, the S&P 500
vacillated between mild losses and gains.
Read: Energy ETFs jump after OPEC+’s unexpected oil-production cut, soaring past S&P 500 in Monday trade
The tech-heavy Nasdaq Composite
COMP
lagged, down 0.8% at 12,124 in recent trade, while the Dow Jones Industrial Average
DJIA
outperformed, gaining 242 points, or 0.7%, to 33,516, thanks to its heavier weighting toward safety plays like healthcare and consumer staples companies. Chevron Corp.
CVX
,
the last remaining oil and gas giant on the Dow following Exxon Mobil Corp.’s
XOM
ouster in 2020, was up 4%.
Stocks and bonds could see more pain ahead
As markets struggled to find direction, some strategists warned that higher oil prices would complicate the outlook for inflation and potentially force the Federal Reserve and other major global central banks to impose additional rate hikes, or delay rate cuts.
Meanwhile, commodity analysts at Goldman Sachs Group increased their year-end price target for Brent crude, the global benchmark, by $5 to $95 per barrel. Others said that the cut would likely lead to substantially higher oil prices, barring a sharp downturn in the global economy.
Rystad’s Leon said the cuts could add another $10 to global oil prices, which could exacerbate headline inflation around the world.
Fed funds futures markets appear to already be taking this to heart: Traders now see a 58.3% chance of a 25-basis-point rate hike in May, up from 48.4% on Friday, according to the CME’s FedWatch tool.
“The anticipated increase in oil prices for the rest of the year as a result of these voluntary cuts could fuel global inflation, prompting a more hawkish stance on interest rate hikes from central banks across the world,” Leon said in a note to clients.
If global inflation does pick up, “it will harm both equity and bond markets,” said Mark Grant, chief global strategist at Colliers Securities, in comments emailed to MarketWatch. The resulting dynamic could look similar to last year’s moves across markets, which saw 60/40 portfolios suffer one of their worst calendar-year losses in recent memory.
The jump in oil prices might make the Federal Reserve’s inflation-fighting job “a little more difficult,” but it is too soon to know for sure, St. Louis Fed President James Bullard said in a Bloomberg Television interview.
Oil prices, however, remain well below year-ago levels. WTI futures are down around 19% from 12 months ago, after crude surged higher in the wake of Russia’s invasion of Ukraine.
So far, bonds are holding up better than stocks. Treasury yields reversed an early spike to trade lower on Monday, with yields falling across the curve. The yield on the 10-year note BX:TMUBMUSD10Y was down 7.7 basis points in recent trade to 3.417%, according to FactSet. Bond yields fall as prices rise, and vice versa.
Norwegian krone, Canadian dollar advance
Production-cut reverberations were also felt in the foreign-exchange market, as currencies like the Norwegian krone and Canadian dollar
USDCAD
benefited from what Bipan Rai, global head of foreign exchange strategy at CIBC Capital Markets, described as the “commodity proxy” effect.
The U.S. dollar fell by 1.2% against the krone
USDNOK
to 10.30, according to FactSet data. The Canadian dollar
CADUSD
gained 0.5% to trade at 74 cents to the U.S. dollar. The ICE U.S. Dollar Index
DXY
,
a gauge of the dollar’s strength that’s most heavily weighted toward the euro, was down 0.4% to 102.1.
How higher oil prices could help fight inflation
To be sure, there was plenty of disagreement about how the latest OPEC+ cut might impact inflation and markets over the long term. The production cuts could “expedite the Fed’s goals via demand destruction,” said CIBC’s Rai in a note to clients.
Others agreed.
“In a lot of ways, this helps fight inflation at the core level, which is where the Fed was trying to lower demand,” said Joseph Sykora, an equity analyst at Aptus Capital Advisors, during a phone call with MarketWatch.
Higher crude prices could force consumers to spend more of their budget on gasoline and other staples, leaving less money for discretionary items and services, which Federal Reserve Chairman Jerome Powell has cited as a major sticking point for inflation.
“This could slow the consumers’ ability to spend elsewhere,” Sykora said.
