Runaway Oil & Rates?

Macro Perspectives: Thu 18 Nov 21

We talked yesterday about Biden's impending decision on who will lead the Fed for the next four years.

The incumbent, Jay Powell, doesn't seem to fit the mold of what the administration wants - though he's the consensus favorite. The highest probable candidate that could replace him, does fit the mold (Brainard).

The "mold," in this case, is (seemingly) someone that will carry the water for the White House's agenda.

With that in mind, markets seem to be pricing in some uncertainty about the situation.

We are living in a world of policymaker intervention. The Fed's involvement in the Treasury, mortgage and corporate bond markets over the past year is intervention. The pandemic response from Congress (stimulus, rent moratoriums, direct checks, etc.) is intervention.

The Fed has now telegraphed a path where they could be out of the intervention business by June - if the infrastructure package is the last bullet fired by Congress, they could be nearing the end of the pandemic-response intervention business too.

However, this Fed appointment, and actions Biden took in the oil and gas market, suggest we may get more intervention, not less.

What are two markets that create problems for the economic recovery? Runaway oil prices, and runaway interest rates.

On the former, we have an administration (and global initiative) that has restricted domestic oil supply, and given the control of prices to foreign producers - giving us a threat of runaway oil prices. On the latter, we have the hottest inflation we've seen in thirty years, following continued massive deficit spending - that's a recipe for higher rates, maybe runaway rates.

Will there be intervention?

Biden launched an investigation into domestic oil producers, claiming producers were price gouging. This claim sounds a lot like the claim that resulted in the Nixon-era gas price controls - it led to much higher, not lower, prices.

For reference purposes, below is the scatter plot of holdings within $XOP (Oil & Gas Exploration & Production) ETF.

On rates: Brainard has been an advocate for yield curve control (managing market interest rates to stated target levels). Just as the Fed is exiting the intervention business, they could be right back in it. This would keep market interest rates from running away, and choking off economic activity - but market interest rates are a market mechanism to curtail inflation. Inflation could run wild.