The Federal Reserve is virtually set to approve a 50-basis-point, or half-percentage-point, rate increase at the end of its May policy meeting on Wednesday – the central bank’s first boost of this scale in more than two decades. That is unlikely to be the Fed’s pinnacle. Money market traders are pricing in a 75 basis point increase at the central bank’s June meeting. If the central bank goes that far, it will do so on the idea that the US economy “can handle it” and that inflation must be fought “at all costs.”
However, can the economy withstand such strong rate rises without being weakened? Or, more precisely, can the job market, which has grown at the same breakneck pace as inflation over the last year, withstand the Fed’s planned crackdown on soaring salaries and labor demand – the central bank’s two primary sources of current price pressures?
If the employment market slows as a result of the Fed, this will have a significant impact on the oil market due to their nexus.
High oil costs may be detrimental to economic development, but not necessarily to an employment market like the one now prevailing in the United States. However, a slowdown in job growth, or worse, a dramatic increase in unemployment–as happened two years ago during the COVID breakout), would almost definitely push oil prices down. Any effect may not be noticed immediately, and certainly not this week when the Fed meets only one day before OPEC+, the global oil-producing coalition whose primary objective, apart from assuring the stability of petroleum supply around the globe, is to keep the price of a barrel over $100.
Increased interest rates are the Fed’s preferred method of combating inflation since they increase the cost of borrowing or investing, which may put a damper on both family and corporate spending. If businesses determine that they no longer need as many employees, the present strong demand for labor may also diminish.
Fed Chairman Jerome Powell says that a steady stream of rate rises this year will help keep inflation under control. In 2021, the US economy and inflation surged at their quickest rates in four decades, while employment growth accelerated to record levels. The latter two have continued to expand at a steady clip although the economy has already begun to decline.
The Fed’s approach focuses on the economy’s demand side. Increases in rates alone will neither improve the supply of employees or allay people’s anxieties of contracting a disease caused by Covid. They are unable to provide child care for working parents, alter immigration policies, or persuade early retirees – estimated to number about 2.6 million – back into the labour field.
Additionally, economists assert that the Fed’s strategy will be exceedingly difficult to implement given the post-pandemic world’s unpredictability. Russia’s invasion of Ukraine has roiled global energy markets, with many Americans expecting to feel the pinch at the pump. Recent Covid plant closures in key Chinese manufacturing centers have exacerbated global supply chain problems, serving as a sobering reminder of the pandemic’s continued economic danger.
Complicating this dual objective of containing inflation and recalibrating the labour market is the Fed’s need to do all of this without prompting firms to lay off workers or start a new recession. The Fed has a mixed track record of increasing interest rates just enough to cool the economy – many analysts refer to 1994 as the year when the Fed raised rates without causing the economy to collapse.
History has often gone in the other direction. Since 1961, the Fed has raised interest rates nine times in order to battle inflation. According to analysis from investment firm Piper Sandler, eight of those efforts ended in recessions.
The US GDP fell by 1.4 percent in the first quarter of 2022. Following a stunning 5.7 percent increase in 2021 as the economy recovered from the COVID horrors of 2020, which resulted in a 3.5 percent GDP contraction, the US experienced its first recession since 2008/09.
“What Powell is suggesting is that ‘this time is going to be different,'” Roberto Perli, a former Federal Reserve economist who is now the director of global policy at Piper Sandler, told the Washington Post. “Perhaps there will come a moment when things will be different. However, it is always a risky statement.“
Additionally, there is another issue.
Just as the Fed is committed to end US inflation, OPEC+ is resolved that oil prices never again reach the Covid 2020 lows. These are the dynamics we must keep in mind because the Fed will not be able to reduce inflation without lowering oil prices – wage spirals and increased demand for workers are only one part of the problem – and OPEC+ is not going to roll over and play dead while the central bank and the combined forces of the Biden administration attempt to sabotage the oil market.
When the going gets tough, OPEC+ will continue to squeeze oil supply in order to prevent prices from falling too much from their current levels. And with summer air travel and US road vacations just around the bend, it may be as tough to keep oil below $100 a barrel as it will be to keep it from reaching the over $140 highs of the Ukraine invasion.
The United States consumer, who accounts for 70% of the country’s GDP, is, however, larger than the Fed and OPEC+.
Reduced pricing remain a primary objective for the millions of Americans who have returned to work in the aftermath of the Covid catastrophe.
Many people think that the Fed will have a hard time giving the economy a soft landing because it plans to raise interest rates so quickly. This is according to a survey from the University of Michigan that was released on Friday.
When consumers fear the worst and eliminate as much discretionary expenditure as possible, growth just grinds down, and practically everything falls with it, including the price of oil.
Only, it may not occur immediately.
Weekly Settlements & Technical Outlook for WTI
On Friday, Brent crude, the global oil standard traded in London, fell $1.18, or 1.1 percent, to $106.08 per barrel.
Brent rose 2.5 percent in a week.It grew by 1.3 percent month on month.It was Brent’s weakest monthly gain since December, but it kept up its winning streak over the last five months, giving longs a 55% profit.
The benchmark for US petroleum, West Texas Intermediate crude, or WTI, fell $1.25, or 1.19 percent, to $104.11 per barrel in New York.
Nonetheless, WTI gained over 2% for the week. For the month, it was up 4.4 percent.WTI, like Brent, has risen every month since late November, accumulating a 58 percent premium over the last five months.
Despite Thursday’s OPEC+ meeting, oil prices are likely to trend downward for the first three days of the week as investors’ attention shifts to the Fed ahead of Wednesday’s rate decision.
WTI’s technical charts also reflect the same thing.
“With weekly stochastic and relative strength indicators in neutral territory, violent swings are expected to persist,“ said Sunil Kumar Dixit, chief technical analyst at SKcharting.com.
Dixit added that WTI is extremely likely to revisit last week’s $101-$98 support levels, where buyers may return to restart the primary positive momentum into the $105-$108 resistance and liquidity levels.
“If this $105 – $108 resistance level draws sufficient buyers, anticipate momentum to continue to $109 – $113 and maybe $116,” Dixit added.
Weekly Activity in the Gold Market
If you thought inflation hedges were the best way to protect against rising prices, things haven’t worked out so well for them again. Their rival’s strongest rise in seven years has knocked them off the top spot.
Gold lost about 2% in April, despite a 1% gain on Friday. This was the metal’s second monthly loss since the start of 2022, but it still managed to stay above the $1,900 per ounce mark.
Gold’s loss occurred as the dollar, the yellow metal’s arch-nemesis, had its largest monthly rise in ten years. The Dollar Index, which compares the dollar to six other major currencies, rose more than 4.6 percent in April, reaching its highest level since January 2015.four of April’s twenty trading sessions saw the dollar index decrease.
The dollar’s outsized surge occurred in anticipation of a Federal Reserve rate hike in the second half of 2022 – and maybe in 2023 – as the central bank seeks to curb US inflation, which is expanding at its highest pace in four decades.
“The dollar surge has been unrelenting and has been a significant drag on the yellow metal – which raises the question, is there anything in the short term that can halt the dollar?” enquired Craig Erlam, analyst at OANDA’s online trading platform. “If that is not the case, what does it signify for gold?”
Front-month gold futures for June on the New York Mercantile Exchange were at $1,896.90 as of Friday’s close, up $5.60, or 0.3 percent on the day.Despite a 4.5 percent year-over-year increase, it fell 1.9 percent month over month.
June gold reached a six-week high of $2,003 on April 18 on worries that the United States might enter recession as a result of strong Fed attempts to curb inflation. Gold is often used as a hedge against economic and political uncertainty.
A series of Fed speakers, however, assuaged market concerns that the economy would turn negative as a result of the central bank’s efforts to contain price pressures increasing at their highest rate in 40 years.
While worries of a harsh landing have not gone away, optimism, particularly over the robust job market, has won over some pessimists. This has resulted in the dollar surging – the primary beneficiary of a rate rise – at the expense of gold and other safe haven assets.
“Gold has had a miserable couple of weeks after breaching over $2,000 for the first time in over a month,” Erlam said. “Gold will continue to appeal to investors seeking a safe haven and an inflation hedge, and as a result, I do not expect the current rate of decline to continue, even if the dollar remains strong.”, there is little reason to be optimistic about the yellow metal if the dollar continues its ascent.“
The Dollar Index reached a 25-month high of 103.945 on Thursday.
US bond rates, which often move in lockstep with the dollar, have also increased in two of the last three sessions, after a recent decoupling from the currency. The 10-year US Treasury note yield increased by about 24 percent in April, its second consecutive record month following a nearly 29 percent increase in March.
Inflationary pressures persisted in the first quarter of this year, with the so-called PCE Index increasing 6.6 percent year to March, although GDP contracted 1.4 percent in the same period. If GDP continues to shrink in the second quarter, the United States will enter recession automatically.
The last time the economy entered recession – defined technically as two consecutive quarters of negative growth – was after the 2020 COVID-19 outbreak.
“The likelihood of consumers reaching a tipping point will increasingly rely on predictions for a solid job market and steady wage growth,” Richard Curtain, chief economist at the University of Michigan, said in Friday’s regularly watched Umich Consumer Sentiment survey.
The labour market has been the brightest light in the US economy in recent years, with employment reaching record highs after a two-year recovery from all-time lows.
Joblessness in the United States reached a record level of 14.8% in April 2020, after the loss of about 20 million jobs as a result of the coronavirus outbreak. On the other hand, employment has been exceptional over the last year, with the unemployment rate dropping to 3.6 percent in March.The Federal Reserve defines “maximum employment” as a jobless rate of 4% or less.
Technical Outlook for Gold
According to Dixit of skcharting, as long as gold remains below $1,900 in the next days, the spot price of gold, which he uses as his primary indicator, might fall below $1,875.
“A prolonged decline below $1870 might drive spot gold below the 50-week Exponential Moving Average of $1,850 and the 100-week Simple Moving Average of $1,837,” Dixit said. “If gold falls below $1837, $1,818 will very certainly act as support.”
While stochastic and RSI readings on a weekly basis were negative, daily oversold metrics may assist limit gold’s loss or perhaps help it catch a bid higher.
“As long as the underlying trend remains upward, institutional purchasing from central banks is expected to resurface for value buying in gold, hence resuming the next wave upward,” Dixit said. “For gold to reverse from the lows, it must first pass $1,900 – $1,935 as a first hurdle, followed by $1,960 and $2,000.”
Barani Krishnan does not own positions in the commodities or securities about which he writes.