How resurgent oil price could affect US rate decision

Wall Street’s confidence in a series of interest rate cuts from this summer is coming under increased strain after oil traded at its highest level since early November.

Brent Crude last night topped $87, up 15% so far this year in a resurgence that’s been fuelled by supply concerns as well as the renewed interest of financial speculators.

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US one-year inflation swaps have reflected the jitters after edging up to 2.64%, their highest level since October. That’s after inflation figures for both January and February came in stronger than expected, with core inflation running at a monthly 0.4%.

Despite the oil price moves, the S&P 500 has set a series of record highs this year as traders position for interest rates to fall back from the 23-year high of 5.25%-5.5%.

This evening’s policy announcement by the Federal Reserve will keep rates unchanged for a fifth month, with chair Jerome Powell set to reiterate the message that inflation will need to be on a sustainable path to 2% before any adjustments can be made.

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The main focus today will be on the Fed’s latest Summary of Economic Projections, including the dot plot for where officials see rates moving over the next few years.

The last one in December pencilled in three rate cuts for 2024, which triggered a significant multi-asset rally as investors grew confident that rate cuts were on the horizon.

Deutsche Bank’s US economists expect the median dot to remain at three cuts in 2024, but they think the Fed will raise their 2025 and 2026 dots slightly to show less easing further out.

Strategist Jim Reid added: “We have argued for some time that central banks face an unenviable challenge in calibrating their policy this year given the long and variable policy lags and the extreme nature of the recent inflation shock and accompanying post-Covid structural shifts.”

The potential for bumps in the inflation road has failed to prevent technology stocks pushing the S&P 500 deeper into record territory, including on the eve of the Fed meeting.

Markets have been reassured by the overall health of the US economy following solid GDP growth figures and signs of a cooler, yet still robust, jobs market.

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UBS Global Wealth Management believes that the incoming economic data will be soft enough for the Fed to begin cutting rates this year.

It noted that the recent move in oil prices came alongside a substantial increase in Brent crude’s open interest, the total number of futures contracts held by market participants at the end of the trading day, to the highest level since November 2021.

UBS sees several factors supporting the return of financial investors in crude oil.

The Swiss bank said oil demand data so far this year has surprised on the positive side, while the extension of the voluntary OPEC+ production cuts for another three months is likely to keep the oil market undersupplied in the second quarter.

It added: “We continue to expect Brent crude to trade in a $80-$90 a barrel range this year, and advise investors with a high risk tolerance to sell Brent’s downside price risks or to add exposure to longer-dated Brent oil contracts.”