U.S. equities are heading for a week of choppy trading, as the rally winds down and the market braces for a period of heightened volatility and heightened risk levels. The typical factors of concern have been today’s high oil prices, yields and the growing concern that the Federal Reserve will be less accommodative than expected.
Market strategist Dan Niles, who founded Niles Investment Management, is in a cautious camp and has said investors should be paying attention to whether there is a continued correlation between oil and interest rates and the economy. The market is now awaiting the Fed’s decision on rates in September.
Oil Prices Surge Above $107
Crude Oil has turned out to be one of the most prominent concern stocks for the investors. Crude oil – Brent crude soared above 107$ a barrel as tension was amplified globally and energy markets were disturbed in the middle-east.
Recent supply worries have brought another element of uncertainty to an oil market that was already dealing with extremely tight spare capacity. If disruptions last for an extended period, they could boost crude prices, raising costs for fuel and transportation across the world’s largest economies.
Higher long-term crude prices mean higher input costs for some businesses and consumers. Airlines, logistics providers, manufacturers and other energy-intensive industries could see margin pressures if the higher crude price persists.
Fed Rate Hike Expectations Rise
The Federal Reserve has moved to the heart of the market’s radar. Broadly speaking, investors are hoping to see the US central bank hike rates by 25 basis points at their meeting in September.
The risk of more aggressive monetary policy has increased given inflation continues to sit above the level the Fed would like to see and a surge in energy costs further risks inflation.
Whenever interest rates go up, they make borrowing more expensive for both companies and consumers. They can also make riskier investments less appealing, once there are safer fixed income investments that pay higher yields.
US 10-Year Treasury Yield Crosses 5%
US Treasuries Another significant cry from the global markets is the direction of US Treasuries. The 10-year US Treasury yield has risen above 5% and climbed to multi-year highs.
Treasury yields higher and then lower Graph When Treasury yields rise, stocks tend to fall – as investors look at the return they could get on a bond and compare that to the return on stocks. Growth stocks, which tend to be more expensive, can take a hit when yields are rising.
The shift higher in yields has already seen volatility rise across the world markets as investors have become risk averse to highly priced technology and growth stocks.
Dan Niles Advises Investors to Remain Cautious
Dan Niles is following these three headline events very intently: 1. How equity markets respond to rising oil and interest rates; 2. Increasingly negative sentiment around artificial intelligence development, and 3. The Federal Reserve’s next move.
Niles has been bearish on US equities at the outset, cautioning against dismissing the messages delivered by bond markets and central banks.
‘His perspective is especially salient right now as markets appear vulnerable at a time when crude is expensive, yields are climbing, geopolitical uncertainty remains and equities are trading at high levels.
Impact on Global Stock Markets
Higher crude prices and elevated US yields are already impacting investor sentiment. US stocks have come under stress and it is also impacting Asian markets as the global macro environment is shifting.
It is not, in any case, that far away from those. Higher oil prices raise the import bill for India, as we are a heavy importer of crude. If interest rates globally move up, it can impact foreign portfolio flows into Indian equities.
Sensex, Nifty Fall 1% on Higher Crude, US Yield On September 15, the Indian benchmark indices were under pressure, with a rise in crude oil prices and the US 10-year Treasury yield climbing above 5%. Sensex and Nifty settled nearly 1% lower led by deteriorating sentiment on global risk currencies.
Why rate and oil investors are stuck watching each other’s backs
The main worry is high oil prices and high interest rates. Usually when the economy slows down, central banks will cut rates. But when energy prices keep inflation high, policymakers will have less room to loosen monetary policy.
This makes it tough for the financial markets.
A sustained period where oil remains above $100 could also push inflation expectations higher. This could tempt central banks to keep their tightening stance longer, which would weigh further on yields and stock prices.
What Lies Ahead for Markets?
The coming weeks are going to be critical for investors worldwide. The Federal Reserve’s rate policy statement, the situation in the Middle East and trajectory of crude oil prices should be the key factor that can decide the markets.
Investors will also be eager to see if the higher Treasury yields stay above the 5% level. Such a move may weigh on equities, especially on stocks with valuations that rely heavily on future earnings growth.
For now, Dan Niles’ advice to investors is: tread carefully. There are many macro risks lining up at once, and it is quite possible the markets will stay volatile.
Will corporate earnings be resilient enough to sustain investment in new technologies like artificial intelligence, and can this offset the drag from oil prices, bond yields and tighter monetary policy? Volatility across global financial markets may be here to stay until investors have more clarity on this.
