Oil Surge Clouds the Path for Global Rate Cuts and Risk Assets
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This week will feature central bank meetings globally, including the Fed, ECB, BOJ, and BOE. With oil prices surging and inflation expectations rising, markets will be focused on the current path of monetary policy and the potential impact higher oil prices may have on these central banks.
The BOJ is clearly in the most precarious position, especially given the outcome of the general election in February and the path it had already been following since the last meeting. Now, with oil trading near $100, the BOJ must tread carefully as USD/JPY approaches 160, a level that could be viewed as the point of no return.
The USD/JPY has already moved above resistance at 159, but it still has further to go to reach the highs last seen in July 2024.
Technically, once above the July 2024 highs, there is no further resistance in USD/JPY, and the yen could weaken significantly.
In the meantime, rising oil prices have changed the narrative around rate cuts in the U.S. Markets have been steadily pricing those cuts out, even though the incoming Fed chair nominee has signaled a preference for easing policy.
December Fed funds futures have risen to 3.44%, and since 2022, expectations for Fed rate cuts have largely tracked oil prices. If oil continues to rise, it will make it difficult for the Fed to cut rates — at least until oil is viewed as pushing the economy toward a recession.
It isn’t just in the U.S. where rates are rising; the 2-year yield in Australia has now eclipsed its October 2023 highs.
Rising global oil prices will tighten liquidity and overall financial conditions. Tighter financial conditions will have negative impacts. As long as oil remains elevated or rises further, it will continue to tighten conditions across the global economy and weigh on risk assets.
So, to understand where risk assets may be headed, one needs to know where oil is going — and, at least in the short term, that may be a difficult task. Weekend oil CFDs are trading up another 3%, and over $100.
As long as oil remains above the 10-day exponential moving average, the trend still appears to be higher for now.
It is pretty much the same for the S&P 500—as long as it remains below the 10-day exponential moving average, the trend appears to be lower.
The distribution pattern in the index is fairly clear, and the key pivot point appears to be around 6,525. That level aligns with the November lows.
More importantly, if one measures the move from the high to that level and projects it out 100%, it suggests the index could fall to around 6,050. That would allow for a gap fill from June 24 and a retest of the breakout from the pre-tariff highs.
That would likely require oil to remain elevated while rates and the dollar continue to rise. The Dollar Index could move higher as well; once it breaks above 100.50, it could have room to climb toward 102.
With momentum just turning positive, it seems probable that CTAs and leveraged funds could begin building positions in the dollar and start unwinding their short exposure.
Meanwhile, the 2-year rate could probably rise a bit further as well, to 3.80%, the next level of resistance, followed by a move to 3.97%. The 2-year is above the 200-day moving average, and the 50-day moving average is turning higher. Plus, it just broke above a multi-year downtrend established in April 2024.
We’ll just have to see how the week unfolds. It is options expiration (OPEX) week, so volatility could be elevated, especially given that put options are currently dominant in the S&P 500, creating the potential for wild intraday swings.
Have a good day.
-Mike
Glossary by ChatGPT
CFDs (Contracts for Difference) — Derivative instruments that allow traders to speculate on price movements of assets without owning the underlying security.
CTA (Commodity Trading Advisor) — A professional money manager or fund that uses futures, options, and other derivatives, often employing systematic or trend-following strategies.
Dollar Index (DXY) — An index measuring the value of the U.S. dollar against a basket of major global currencies.
Exponential Moving Average (EMA) — A type of moving average that places greater weight on recent prices to identify short-term trends more quickly.
Financial Conditions — A broad measure of market liquidity, borrowing costs, credit availability, and asset prices that influence economic activity.
OPEX (Options Expiration) — The scheduled date when listed options contracts expire, often associated with increased trading activity and volatility.
Put Option — A derivatives contract that gives the holder the right, but not the obligation, to sell an asset at a predetermined price before expiration.
Resistance — A technical level where selling pressure historically prevents an asset’s price from moving higher.
USD/JPY — The foreign exchange rate representing how many Japanese yen are required to purchase one U.S. dollar.
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