Weekly Market Update: Oil spikes as US inflation hits Fed target

Mon 02 Jul 2018

Read our full Market Update Week 26

Market Update

Global equities saw a second straight week of negative performance, down -0.7% in Sterling terms, with all major indices experiencing falls in both local and GBP terms. Once again escalating trade tensions were the prime reason for weak performance, although for the second week running UK stocks did relatively well (down -0.5%) as Donald Trump’s calls for allies to halt oil imports from Iran boosted energy stocks. US equities fell -0.9%, led lower by IT stocks which were badly hit on Tuesday due to reports that the US was considering restrictions blocking companies with more than 25% Chinese ownership from buying US tech firms. Elsewhere European, Japanese and Emerging Market equities were down -0.6%, -1.0% and -1.0% respectively. Sterling fell -0.4% vs USD and -0.7% vs EUR. Government yields fell across the board, with UK 10Y Gilt yields down -4.1bps, US 10Y Treasury yields down -3.5bps and German 10Y Bund yields down -3.5bps, so that global bonds returned 0.6%. In the commodities space Gold fell -1.3% and Oil gained +7.5%, both in USD terms.

CIO Analysis

Oil jumped up to $75 last week, as traders closed their short positions. With oil up 22% since the beginning of the year (26% in Sterling terms), energy prices are quickly becoming an important consideration in policy decision making. And while policy makers tend to focus on “core inflation”, i.e. inflation ex energy prices, higher oil means higher input and transportation costs, which ultimately leads to higher prices for all goods and services. Short periods of oil inflation don’t in theory hurt the economy much. However, they do tend to have an effect on margins, especially for companies who don’t use futures to hedge. They may also affect consumers, as airlines (have you booked your holidays yet?) and other energy-sensitive sectors move much faster than the consumer price index. Protracted high energy prices would have an effect on the whole supply chain, something policy makers are very much aware of. What does this mean in practice? It could tilt borderline interest rate decisions to being more hawkish. A fourth rate hike from the Fed, one or even two hikes from the BoE and a rate hike from the ECB before H2 next year could become a reality if oil prices persist at higher levels.

David Baker, CIO