Rising Oil Prices Begin to Tighten Financial Conditions
The continuing theme is rising oil prices, with Brent crude now trading around $106 and WTI near $97. While it had been clear that at the end of March the market appeared to be ignoring oil moves, that dynamic has shifted over the past few days. At this point, a move back to $110 in Brent does not seem like much of a stretch.
This is now causing credit spreads to widen again. The CDX HY Credit Spread Index moved out to roughly 331 today. While that level is still low, what matters is that, after falling sharply, it has stopped tightening. If the index begins to form higher lows from here, that would be meaningful going forward.
It is too early to confirm that at this stage, but at least there is something to work with.
Additionally, today we saw 1-year inflation swaps rise and break out of a pennant pattern, suggesting potential upside. If sustained, this could indicate that inflation expectations are set to increase in a more meaningful way.
The same can be said of the US 2-year rate, which rose by nearly 3 bps on the day and moved above the 3.8% resistance level. If oil continues to rise and inflation expectations move higher as well, it would suggest that 2-year rates could begin to head back toward 4%.
It is a similar setup for USD/JPY, which also appears to be breaking out of a bull flag. If that holds, the pair could move back through the prior highs around 162 seen in 2024.
If these trends continue, financial conditions are likely to tighten again, which would be unsupportive of risk assets. What makes matters worse is that this is happening at a time when reserve balances have fallen to around $2.9 trillion — their lowest level since the end of 2025. In essence, that suggests liquidity is thin at best, at least for now.
That showed up today in the PSP, the Private Equity ETF, which fell by more than 3%. We know PSP tends to be sensitive to liquidity changes, and the S&P 500 often lags moves in that sector.
Additionally, after a couple of days of trying to move above its 200-day moving average, the XLF financial ETF has failed and pulled back. A move back below $51 would be a negative for the group and the broader market.
-Mike
Glossary by ChatGPT
Brent Crude: A global benchmark for oil prices, reflecting supply and demand dynamics in international markets.
Bull Flag: A bullish chart pattern indicating a potential continuation of an upward price trend after a consolidation phase.
CDX HY Credit Spread Index: An index tracking the cost of insuring against default in high-yield corporate debt markets.
Credit Spread: The yield difference between corporate bonds and comparable government securities, reflecting perceived credit risk.
Inflation Swap: A derivative contract allowing investors to exchange fixed payments for payments linked to realized inflation.
Liquidity: The ease with which assets can be bought or sold in the market without affecting their price.
Pennant Pattern: A technical chart formation signaling a potential continuation of a prior trend following a brief consolidation.
Reserve Balances: Deposits held by banks at the central bank, often used as a proxy for system-wide liquidity.
Resistance Level: A price point where upward movement tends to stall due to increased selling pressure.
WTI Crude: A key U.S. benchmark for oil prices, commonly used in domestic energy markets.
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