As a rule, I try to stay focused on energy here, and reference broad economic conditions only as one of the many factors that influence those markets. In that context, any single economy, even one as big as the U.S., is not that significant. Right now, though, fears about global growth are dominating oil prices, and the U.S. remains one bright spot in an otherwise sluggish global picture. Data released Friday morning, however, suggest that that may be changing, so a look at the U.S. economy is justified.
The jobs report released by the U.S. Labor Department is one of the most important sets of numbers every month. That has been especially true during the recovery from the last recession. Early on, a healthy jobs market was seen as the main indicator of the pace of recovery, but recently the import of the report has changed. It is now parsed to give clues as to what the Fed is likely to do.
That has resulted in the stock market behaving counterintuitively at times. This morning, for example, we learned that less jobs were added in September than predicted, but the stock market jumped, and oil followed suit. The weakness was seen as making it even more likely that the Fed would cut interest rates further. That would cause bond yields to fall and make stocks more attractive on a relative basis, so the jump in the major stock indices makes sense.
What doesn’t necessarily make sense is oil following stocks on the news.
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Obviously, the stimulative effects of a rate cut will help with demand in the short-term, but energy investors should be paying attention not to the prospects of a cut, but what makes it likely.
The fact is that the Fed is not just cutting rates to make Donald Trump happy. The minutes of recent meetings of the FOMC make it clear that most of the committee’s members believe that action is needed to stave off a serious drop in growth, or at least minimize its effects. For oil, the threat of a slowdown in America is more important than the short-term boost to stocks from cheaper money.
That threat was emphasized this week by the release of weak data for both the manufacturing and service sectors, as well as the jobs report. The ISM Manufacturing Index fell to 47.8 in September. That is a multi-year low and any reading below 50 indicates contraction in the sector. That indication of a slowdown was reinforced on Thursday, when the non-manufacturing index from the same source also fell to its lowest level since 2016.
All of that taken together makes it likely that, despite Fed Chair Jerome Powell’s insistence that the rate cuts so far are a “mid-term adjustment” to policy, the U.S. is actually in the latter part of the business cycle. To translate that from economist speak to plain language, a U.S. recession probably isn’t far off.
So, what does all that mean for energy investors?
For now, from a short-term, trading perspective, a bullish stance on oil looks like the best bet. The prospect of rate cuts from the Fed will lead to an optimistic mood that will benefit all risk assets for a while. There is also the possibility of further escalation in the conflict in the Middle East or another attack on Saudi oil assets that make shorting oil a risky proposition. Eventually though, the fact that those cuts are coming in response to a very real slowdown in economic activity will become the focus and when it does, a sharp reversal will follow.