Oil Surge Challenges Fed Rate Cut Expectations

The S&P 500 rose by around 25 bps, but the index didn’t fare as well today, given that volatility fell sharply yesterday and there was less room for further declines. The index also managed to rise up to the 10-day exponential moving average, where it failed.

Tomorrow is, of course, Fed day, and while no change in the overnight rate is expected, the Fed will be releasing its dot plot. Market expectations have shifted toward fewer rate cuts than previously expected, given the surge in oil prices.

December Fed funds futures are trading around 3.4%, and the median projection at the previous FOMC meeting in December was also 3.4%. So there is a chance the median dot for this year moves up to around 3.6%, implying no rate cuts this year.

Oil and Fed funds futures have moved together for a long time, so higher oil likely means fewer rate cuts. As long as oil remains elevated, the odds of rate cuts likely vanish, even with a new Fed chair coming.

Oil and the dollar index have also been closely linked over the last few years.

Ultimately, this means oil is in charge, and the Fed will have to take its cues from it, like everything else. The breakout is clearly significant, and the trend remains higher until it breaks below the 10-day exponential moving average. Additionally, there is strong support at $94 and $90.

The last time oil was at $94 was in September 2023. It rose from about $70 in June 2023, when the S&P 500 was trading near 4,560. Over the course of that move higher in oil, the S&P 500 fell nearly 11%.

Oil is up more now than it was then, and the S&P 500 has only fallen by around 4%. I would also say the speed of the move has been faster and more severe than it was back then. Still, the impact on risk assets is muted. Maybe the move just hasn’t been fully absorbed by the markets yet.

Mike

Glossary by ChatGPT

10-day Exponential Moving Average (EMA): A short-term technical indicator that gives greater weight to recent prices to identify trend direction.
Basis Points (bps): A unit of measurement equal to 0.01%, commonly used to describe changes in interest rates or yields.
Dollar Index (DXY): An index that measures the value of the U.S. dollar relative to a basket of foreign currencies.
Dot Plot: A chart published by the Federal Reserve showing individual policymakers’ projections for future interest rates.
Fed Funds Futures: Financial contracts that reflect market expectations for the future level of the federal funds rate.
Federal Open Market Committee (FOMC): The Federal Reserve’s policy-making body responsible for setting interest rates.
Overnight Rate: The interest rate at which banks lend reserves to each other on an overnight basis, targeted by the Federal Reserve.

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