In a surprise move, OPEC+ members have slashed their oil production by 1.16 million barrels per day. While oil prices spiked on the news, stock markets are holding steady.
The rise in oil prices nonetheless complicates the picture for the Fed which already has a lot on its plate.
Notably, the production cut is not the official decision of the OPEC+ cartel and is purely voluntary. Notably, in January 2021 also Saudi Arabia announced a surprise voluntary production cut which helped support oil prices.
Saudi Arabia described the current round of production cuts as a “precautionary measure” amid the recent fall in oil prices.
Previously Russia also announced that it would cut oil production by 0.5 million barrels per day – which effectively drains 1.6 million barrels of oil from the markets.
As expected, the US has criticized the move to cut oil production. In 2021 and 2022 also, OPEC and Saudi Arabia did not heed US calls to increase oil production.
A few years back, Saudi Arabia and other OPEC members prioritized protecting their market share amid the US shale oil boom. However, they are now more concerned about the pricing and have been willing to lose some market share in a bid to support oil prices.
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Thanks to higher oil prices, Saudi Arabia’s state-owned oil company Aramco posted record profits and cash flows in 2022.
While the broader US markets have mostly shrugged off the steep rise in oil prices today, it compounds the worries for the “data-dependent” Fed – which has the mandate to lower inflation to 2%.
Oil Price Rise Might Lead to Increase in Inflation
US inflation has fallen from the June 2022 highs when the annualized CPI peaked at 9.1%. The metric fell to 6.0% in February and has since fallen in every month since June.
Among others, the fall in oil prices helped lower inflation. After OPEC’s production cuts, several analysts including Energy Aspects’ founder Amrita Sen and CMC Markets’ analyst Tina Teng expect crude oil prices to hit $100 per barrel.
The Fed is already grappling with high services inflation – which has been further compounded by the strong US job market.
A further and sustained rise in oil prices would make the Fed’s job only tougher. Last month, the US central bank raised rates by 25 basis points and its dot plot showed that FOMC members see one more 25 basis point rate hike in 2023.
Powell meanwhile ruled out rate cuts in 2023 even as many market participants believe that slowing growth would force the Fed to cut rates in the second half of 2023.
Higher Energy Prices Make Fed’s Job Complicated
Markets meanwhile misread Fed’s resolve to fight inflation last year also and far from the “pivot” that many expected, the US central bank raised rates to the highest level since 2007.
High inflation is invariably negative for risk assets like growth stocks. However, some investment strategies can outperform during high inflation.
High inflation and Fed’s rate hikes drove down US stocks in 2022 and the tech-heavy Nasdaq Composite lost a third of its value.
Despite the volatility this year, US stocks, especially tech names have performed well.
The Nasdaq rose 16.8% in the first quarter and had its best quarter since 2020. The tech-heavy index’s fortunes whipsawed in the quarter though. While January was the best month for Nasdaq in over two decades, it crashed in February.
However, it rebounded almost 6.7% in March as investors bought the dip in tech stocks.
The rally has at least been partially fueled by hopes that US inflation would continue to taper down in 2023 – as has been the case for the last eight months.
If crude oil prices indeed rise to $100 per barrel, that assumption might wither away – so would a lot of calculations of the Fed.
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This article was written for Business 2 Community by Mohit Oberoi.
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