The VIX, Wall Street’s fear index, rose to 21 this morning, pricing in fears that the debt ceiling talks don't go well, and/or rates will rise further. Oil prices shone on news that supplies might tighten in the near future, bad news for economic growth and inflation. Today’s release of the minutes of the May Federal Reserve meeting reported significant uncertainty on where rates go next.
Policy errors pose a risk
Financial markets are starting to believe that interest rates will continue to rise after a period in which an anticipated peak and decline were widely anticipated. The Fed has the unique challenge of withdrawing the roughly $5 trillion of fiscal and $5 trillion of monetary stimulus, Covid-era hangovers, in an orderly manner. For the Fed, these are unprecedented times with few historical examples to rely upon in making their decisions, which raises the possibility of policy error.
Fed minutes point to future rate hikes
The minutes of the May Federal Open Market Committee meeting showed that Fed officials were divided about where to take interest rates: some were in favor for more increases to curb inflation; others expected a slowdown in growth to remove the need to tighten further. Various Fed officials have suggested publicly that further rate hikes are a possibility, and Fed fund futures are currently pricing in 30% odds that we see another rate hike at the June meeting, That talk contributed to Treasury yields moving up to two-month highs in recent days.
Debt ceiling talks edge towards deadline
A lack of progress on the debt ceiling talks worries traders a bit more now each day that we move closer to the deadline, which Treasury Secretary Janet Yellen says is the first of June. Traders still expect a deal between the White House and House Republicans, but accidents happen when you remove margin from the equation, and that concerns traders. The two sides are said to be close, but also far apart. Partisanship is at an all-time high in Washington, so leaders struggle to come to the middle, because their parties are so far apart – that’s why nervousness is creeping back onto Wall Street as the deadline approaches.
Jamie Dimon predicts higher rates
JP Morgan CEO Jamie Dimon warned this week that “everyone should be prepared for rates going higher from here. You should be prepared for 6 or 7 percent.” He warned that we could see more risks in the banking sector as a result. Keep in mind that we’ve never before seen the kind of stimulus injected into the economy like we saw during the pandemic – roughly $5 trillion of fiscal and $5 trillion of monetary stimulus.
US, OPEC+ oil supplies falling
Tightness in the oil market is becoming evident, according to data from the Energy Information Administration. US crude oil supplies, ex the Strategic Petroleum Reserve, fell 12.5 million to 455.2 million barrels in the week ending May 19, 3% below levels typically seen in mid-May. Gasoline supplies dropped by 2.1 million barrels, 8% below the five-year average for the week, and Distillate stocks declined 0.6 million barrels, 18% below seasonal levels. Saudi Arabia's energy minister Prince Abdulaziz bin Salman Al Saud, said short-sellers betting oil prices will fall should "watch out" for pain, perhaps signaling that OPEC+, the Organization of Petroleum Exporting Countries and allies including Russia, could consider further increase output cuts at a meeting on June 4.
Bottom line – risk-off
Financial markets moved decidedly into the risk-off camp today as traders began to reflect a higher risk of further rate rises, oil prices moving higher, and the unresolved debt ceiling agreement.
TODAY’S MAJOR MARKETS
- The S&P 500, Nasdaq 100 and Russell 2000 were off 0.9%, 0.8% and 1.2%, respectively, after the release of Fed meeting minutes, and the KBW Regional Bank Index has fallen 2.0% today
- The DAX and FTSE 100 and were off 2.1% and 1.8%, respectively
- The VIX, Wall Street’s fear index, rose 9.0% to 20.2, a clear sign of growing investor unease
Currencies and Bonds
- The dollar index was up 0.4% against a basket of currencies, hitting a 2-month high, while Euro/Dollar and Dollar/Sterling were down 0.2% and 0.4%, respectively
- Yields on 2- and 10-year Treasuries were higher at 4.36% and 3.72%, but not moving as much as news on rate rises and the stalling budget talks might require
- Gold prices broke support levels, down 0.4% at $1,966 per ounce
- Crude oil prices rose 1.3% to $73.9 per barrel, having touched $75 earlier, following a Saudi warning to traders holding large short positions and news that US supplies are tight
- The grain and oilseed sector is mixed to weaker in early trade
A nuclear accident waiting to happen?
- The Zaporizhzhya Nuclear Power Plant (ZNPP), Europe’s largest nuclear power plant in southern Ukraine, lost all external power for several hours Monday, needing backup generators to cool reactors to prevent a major radiation incident
- This poses a risk to an important source of grain exports to the world
- There are unconfirmed reports that Russian forces have placed charges on some of the reactors that could be detonated if they are forced to withdraw, with catastrophic human implications and rendering a large area of highly productive agricultural land unproductive for decades
- This was the seventh time that the plant had been completely disconnected from the electrical grid since the Russian invasion 15 months ago
- International Atomic Energy Agency (IAEA) Chief Rafael Mariano Grossi stated that the situation demonstrated “the highly vulnerable nuclear safety and security situation” at the plant that has come under shelling at times during the war
- He went on to say, “We’re playing with fire. We must act now to avoid the very real danger of a nuclear accident in Europe, with its associated consequences for the public and the environment”
Analysis by Arlan Suderman, Chief Commodities Economist: [email protected]
Market outlook by Paul Walton, Financial Writer: [email protected]