An OPEC Cut Will Accelerate Rate Hikes


November 28, 2016, 4:45pm EST

With Thanksgiving behind us, we a few key events ahead for markets before we can put a bow on things and call it a year.

As things stand, the S&P 500 is up around 8%, right in line with the long term average return (less dividends).  Yields are around 2.3%.  That’s right about where we left off at the end of 2015 (following the Fed’s first move higher on rates since the crisis).

We may find a round trip for oil as well before the year it over.  On Wednesday, we’ll finally hear from OPEC on a production cut. Remember, it was late September when we were told that the Saudis were finally on board for a production cut, to get oil prices higher and to stop the bleeding in the oil revenue dependent OPEC economies.

As we’ve discussed, it was Saudi Arabia that blocked a cut on
Thanksgiving day evening two years ago.  And that sent oil into a spiral from $70 to as low as $26.  Importantly, cheap oil has not only represented a threat to global economic stability but it’s been deflationary.  The threat to stability and the deflationary pressure is what has kept the Fed on the sidelines, reversing course on their rate hike projections for this year, and then, conversely, becoming progressively more and more dovish since March.

You can see in this graphic from the Fed last December (2015) after they decided to hike for the first time coming out of the crisis period.

nov28 fed
Source: Fed

The majority view from Fed members was an expectation that the Fed funds rate would be about 1.375% at this point in th year (2016).  As we know, it hasn’t happened.  As of two months ago, the Fed was expecting rates to be at just 1.00% by the end next year.

This makes this week’s OPEC decision even more important, given the market’s and Fed’s expectations on the path of monetary policy at this point.

If OPEC does as they’ve indicated they will do this week, by announcing the first production cut in oil in eight years, it could send the price of oil back to levels of two years ago — when the oil price bust was started that Thanksgiving day.  That’s $70.

And $70 oil would play a huge role in where rates go next year, in the U.S., and in Europe and Japan.  The inflationary pressures of $70 oil could put the Fed back on a path to hike three to four times in the coming year (as they intended coming into 2016).  And it could create the beginning of taper talk in Europe and Japan.

If we consider that possibility, it makes for a remarkably dramatic change in the global economic outlook in just five weeks (since the Nov 8 election).  As Paul Tudor Jones, one of the great macro traders of all-time, has said: “the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.”  An OPEC move should cement the top in bonds.

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