Oil Prices Send a Warning That the Fed Is Toast


Oil prices - Oil Prices Send a Warning That the Fed Is Toast

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I’ve been warning about oil prices reversing and heading lower over the last couple of months independent of war. I have argued that a turnaround in energy would ultimately happen and be consistent with my credit event thesis.

The implications here are actually very important. A move lower in oil suggests that the Federal Reserve overtightened and the financial system is at risk.

Why? At the core, there are two primary sources of inflation: demand pull (driven by consumers buying things) and cost-push (driven by commodities).

The demand-pull side of things is clearly waning. Consumers are tapped out, high credit card rates are slowing down purchases, and the behavior of retail stocks going nowhere confirms that things are fizzling out.

If the decline of oil prices continues, that breaks the commodity cost-push inflation (at least for now). Oil is highly tied to inflation expectations because oil goes into every single part of the economy. And while everyone thought the Israel-Hamas war would cause a spike in oil prices, we have seen the opposite.

Oil, if anything, is sending a disinflation message now.

Keep in mind that most major recessions and stock market collapses happen AFTER oil prices begin a precipitous drop. So, for this to be happening is a pretty big deal. It suggests that the Fed’s current high interest rates are not only restrictive, but significantly so.

Small-cap stocks and Treasurys are also confirming this narrative.

Last week saw strong performances from both, but this week so far has been telling. Long-duration Treasurys are rising in price and look set to take out the prior week’s highs, which means lower yields. Small-cap stocks are reversing. Falling oil is disinflationary, which pushes long-duration yields down. Disinflation against a tapped-out consumer also hurts small-cap stocks which are far more sensitive to the domestic economy’s growth than large-cap stocks. And while it’s only been just a couple of days of this behavior, should this continue, it suggests that something much more important is happening beneath the surface.

We are not out of the woods yet. This remains a very challenging and dynamic environment that will continue to challenge narratives.

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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