By Barani Krishnan
Investing.com — The Federal Reserve looks almost certain to approve a 50-basis, or half-percentage, point rate hike at the conclusion of its May on Wednesday – its first hike of such magnitude in over 20 years. That likely won’t be the peak yet for the Fed. Money market traders are pricing in a 75-bps hike at its June meeting. If the central bank goes that far, it’ll be on the assumption that the U.S. economy “can take it” and that inflation must be beaten “at all cost”.
But can the economy really take such aggressive rate hikes, without being worn down? Or rather, can the job market, growing as mind-bogglingly as inflation over the past year, absorb the clampdown the Fed is planning, particularly on spiraling wages and demand for workers – the two major culprits of current price pressures, at least according to the central bank.
If the job market slows down because of the Fed, this will have important implications on the oil market because of the nexus between the two.
High oil prices can hurt economic growth but not, necessarily, a job market like the one in the U.S. now. But a slowdown in jobs growth, or worse, a sharp spike in unemployment – just like two years ago, at the height of the Covid breakout – will almost certainly drive crude prices lower. Any impact might not be felt right away and probably not this week, when the Fed meeting is just a day before that of OPEC+, the global oil producing alliance whose job more than ensuring the stability of crude supply to the world is to ensure that a barrel stays above $100.
Higher interest rates are the Fed’s go-to mechanism for tackling inflation, as they make the cost of borrowing or investing more expensive, and can put a damper on spending by both households and businesses. If companies decide they don’t need as many employees, then the current high demand for workers could also ease up.
Fed Chairman Jerome Powell argues that a steady series of rate hikes this year can bring down . Both the U.S. economy and inflation expanded at their fastest pace in four decades in 2021 while jobs growth hit record highs. The last two have continued growing without a blip while the economy is already slowing.
The Fed’s plan tackles the demand side of the economy. Rate hikes alone can’t increase the supply of workers or assuage people’s fears of getting sick from Covid. They can’t provide child care for working parents, change immigration policy or entice early retirees – some 2.6 million by some estimates – back into the labor force.
Economists also say the Fed’s plan will be extremely difficult to pull off given the uncertainty of the post-pandemic world. Russia’s invasion of Ukraine has roiled global energy markets, with the widespread expectation that American households will feel the sting at the gas pump. Recent Covid shutdowns at major Chinese manufacturing hubs have also renewed global supply chain woes, and offer a sobering reminder of the pandemic’s ongoing economic threat.
Complicating this twin goal of tackling inflation and recalibrating the job market is that the Fed must do it all without causing businesses to lay people off or triggering a new recession. The Fed has an uneven track record of raising rates to cool down the economy just enough – many economists point only to 1994, when the Fed managed to hike interest rates without causing the economy to contract.
History has often gone the other way. Since 1961, the Fed has launched nine full cycles of rate hikes to combat inflation. Recessions followed eight of those tries, according to research from the investment bank Piper Sandler.
The first quarter of 2022 has already seen a 1.4% contraction in . That came after a phenomenal 5.7% jump in 2021 as the economy rebounded from the Covid ravages of 2020 that caused a 3.5% GDP decline that year, leaving the U.S. with the first recession since 2008/09.
“What Powell is saying is ‘this time is gonna be different,’” Roberto Perli, a former Fed economist and now head of global policy at Piper Sandler, said in comments carried by the Washington Post. “Maybe there will be a time when it’s different. But that’s always a dangerous thing to say.”
There’s also another problem.
Just like the Fed is determined to break the back of the U.S. inflation, OPEC+ is determined that oil prices never again see the lows of Covid 2020. These are the dynamics we have to keep in mind as the Fed isn’t going to be able to reduce inflation without getting oil prices down – wage spiral and demand for workers being just one part of the problem – and OPEC+ isn’t going to roll over and play dead while the central bank and the combined forces of the Biden administration try to take an ax to the oil market.
When push comes to shove, OPEC+ will keep squeezing crude production to ensure prices don’t fall too far from where they are. And with the advent of summer air travel and U.S. road trips just around the corner, it might be hard to keep oil below $100 a barrel as much as it might be difficult to prevent it from testing the highs of Ukraine invasion, which were almost $140.
There is something, however, bigger than even the Fed and OPEC+ and that is the U.S. consumer, who accounts for 70% of the country’s GDP.
Lower prices remain a top priority for millions of Americans who have returned to work since the Covid crisis.
The latest U.S. consumer poll published by the University of Michigan on Friday showed that many Americans think the Fed will have a hard time providing a soft landing for the economy from the aggressive rate hikes it has planned.
When the consumer fears the worst and cuts as much discretionary spending as possible, growth will simply grind lower, and with that, almost everything will fall, including the price of oil.
Only, it might not happen right away.
Oil: Weekly Settlements & WTI Technical Outlook
In Friday’s trade, crude, the London-traded global benchmark for oil, settled down $1.18, or 1.1%, at $106.08 a barrel.
For the week, Brent rose 2.5%. For the month, it rose 1.3%. While it was Brent’s smallest monthly gain since December, it nevertheless ensured an unbroken winning streak over the past five months that gave longs in the global crude benchmark a windfall of 55%.
In New York, the , or WTI, benchmark for U.S. crude settled down $1.25, or 1.19%, at $104.11 per barrel.
Yet, for the week, WTI rose almost 2%. For the month, it was up 4.4%. Like Brent, WTI has gained every month since the end of November, accumulating a premium of 58% over the past five months.
Despite Thursday’s OPEC+ meeting, oil prices could trend lower the first three days of the week as investors’ focus as a whole rests on the Fed ahead of the central bank’s rate decision on Wednesday.
Technical charts for the WTI suggest the same too.
“With weekly stochastic and Relative Strength Indicators positioned in sideways-range with neutrality, wild swings will likely continue,” said Sunil Kumar Dixit, chief technical strategist at skcharting.com.
WTI is very likely to retest the $101 – $98 support areas of last week, where buyers may resurface to resume the main bullish momentum aiming for the $105 – $108 resistance and liquidity areas, Dixit said.
“If this $105 – $108 resistance area attracts enough buyers, expect momentum to ride higher to $109 – $113 and even extend to $116,” Dixit said.
Gold: Weekly Market Activity
The world’s much-touted hedge against inflation is again finding it difficult to live up to its billing, usurped by its rival’s biggest rally in seven years.
Gold finished April down almost 2% despite a 1% rise on Friday, marking its second monthly loss since the start of 2022, despite holding above the relatively bullish level of $1,900 an ounce level.
Gold’s decline came as yellow metal’s nemesis, the dollar, scored its biggest monthly gain in 10 years. The , which pits the greenback against six other major currencies, soared more 4.6% for April, its most since January 2015. Of the 20 trading sessions for April, the Dollar Index had only declined in four, in one of the most remarkable winning streaks for the greenback.
The dollar’s outsize rally came in anticipation of a higher rate regime the Federal Reserve was expected to adopt over the remainder of 2022 – and possibly 2023 – as the central bank aims to contain U.S. inflation growing at its fastest pace in four decades.
“The dollar rally has been relentless and it’s been a real drag on the yellow metal – which begs the question, is anything going to stop the dollar in the near term?” asked Craig Erlam, analyst at online trading platform OANDA. “If not, what does that mean for gold?”
As Friday’s session wrapped April trading for markets, front-month for June on New York’s Comex stood at $1,896.90 – up $5.60 or 0.3%, on the day. For the month, it was down 1.9%, even as it showed a gain of 4.5% on the year.
Just on April 18, June gold hit a six-week high of $2,003 on concerns that the United States could run into recession from aggressive Fed actions to control inflation. Gold typically acts as a hedge against economic and political fears.
A succession of Fed speakers had, however, soothed some market worries that the economy could turn negative from the central bank’s attempts to put a lid on price pressures growing at their fastest pace in 40 years.
While fears of a hard landing for the economy have not evaporated, optimism, especially over the sterling labor market, have won over some pessimists. That has sent the dollar – the chief beneficiary of a rate hike – rallying instead, making gold and other safe havens suffer.
“It’s been an awful couple of weeks for gold since breaking above $2,000 for the first time in over a month,” Erlam noted. “Gold will continue to see safe haven and inflation hedge appeal so I don’t see the recent rate of decline continuing, even if the dollar remains strong. That said, there isn’t much of a bullish case for the yellow metal if the dollar continues to tear higher.”
In Thursday’s trade, the Dollar Index hit a 25-month high of 103.945.
U.S. bond yields, which often run side-by-side with the dollar, have also risen in two of the past three sessions, after decoupling lately from the greenback. The yield on the rose almost 24% for April – its second blockbuster month after a near 29% gain in March.
Inflationary pressure has continued in the first quarter of this year, with the so-called PCE Index growing 6.6% in the year to March, while GDP fell 1.4% for January-March. If the GDP contracts in the second quarter as well, the United States would automatically be in recession.
The last time the economy slipped into recession – which is technically defined as two straight quarters of negative growth – was in the aftermath of the 2020 COVID-19 outbreak.
“The probability of consumers reaching a tipping point will increasingly depend on prospects for a strong labor market and continued wage gains,” Richard Curtain, chief economist at the University of Michigan, said in the closely-followed poll for April released Friday.
The labor market has been the brightest spot of the U.S. economy in recent times, with employment having hit record highs after rebounding all-time lows just two years ago.
Joblessness among Americans reached a record high of 14.8% in April 2020, with the loss of some 20 million jobs in the aftermath of the coronavirus breakout. Employment has, however, been stellar over the past year, with the jobless rate moving down to 3.6% in March. A jobless rate of 4.0% or below is regarded by the Federal Reserve as “maximum employment”.
Gold: Technical Outlook
Dixit of skcharting said as long as gold held below $1,900 in the days ahead, the , which he uses as his main gauge, could move lower to $1,875.
“A sustained move below $1870 may push spot gold down to the 50-week Exponential Moving Average of $1,850 and the 100-week Simple Moving Average of $1,837,” said Dixit. “If gold breaks below $1837, $1,818 will likely to hold as support.”
But while weekly stochastic and RSI levels were bearish, daily oversold parameters may help reduce gold’s downside or even help it catch a bid higher.
“As the primary trend is still up, institutional buying from central banks is supposed to resurface for value buying in gold, which should resume the next wave up,” Dixit said. “On reversal from the lows, gold will have to clear $1,900 – $1,935 as first hurdle, followed by $1,960 and $2,000.”
Disclaimer: Barani Krishnan does not hold positions in the commodities and securities he writes about.