Can Stocks Force The Hand Of The Fed … Again

May 2, 5:00 pm EST

We talked about the technical reversal signal in stocks that developed yesterday, following the Fed press conference.

Stocks continued lower today. We’ve now had a quick 2% decline from the top.

And now we have this technical breakdown in oil as well (the break of the yellow trendline from the Dec lows).

In the post-financial crisis world we live in, oil prices going down is generally representing a gloomier outlook on global growth and global demand. Oil prices going up is good news — representing a hotter demand/hotter growth outlook. And as you can see below, oil prices and stock prices have tended to move together.

The recovery in oil prices has been almost in lock-step with the recovery in stocks (aggressively bouncing). Crude is up 57% in four months.

Now, yesterday I asked the question: Can stocks force the hand of the Fed, again (i.e. can lower stocks force a rate cut from the Fed)?

If oil prices were to fall hard from here, then maybe. Why? The Fed is afraid of deflationary pressures. And while they like to talk about their assessment of inflation, excluding the effects of volatile oil prices, they have a record of acting on monetary policy when oil prices are falling quickly — especially in this post-crisis environment where deflation has been a persistent threat throughout. They acted in 2016, and they’ve acted in early 2019 — in both cases taking projected interest rate hikes off of the table.

But the case for another crash in oil prices isn’t there. We continue to have supply cuts outside of the U.S. (OPEC and non-OPEC countries). Trump has recently stepped up sanctions against Iran, with the goal of taking Iranian oil exports to zero. That takes supply out of the market. And the political crisis in Venezuela has created supply disruptions for the oil market.

The shale industry is expected to plug the supply gap. As it stands, the shale industry may or may not be able to. But keep in mind, oil demand has been estimated on what is (and has been) low expectations for the global economy. If we’ve seen a bottom in China, it would set up for positive surprises in the global economy. And that means the supply necessary to meet global oil demand, would be underestimated. With that, higher (if not much higher) oil prices from here remain the higher probability scenario.

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