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Over the past several weeks, we have witnessed a rather sudden shift in the narrative that is focused on the global supply/demand matrix of petroleum. That shift in narrative is most easily seen in the price of crude. Crude has traded roughly 40% higher from lows established on February 11th. That reversal in pricing is due to a wide variety of factors ranging from tightening supply as a result of some major producers freezing production to an all out cut in active rigs. The impact of a roughly 750,000/bbl reduction in daily supply as a result of these cuts has afforded crude to establish a low in the $30/bbl range. That low and the subsequent rally by both WTI and Brent has provided equity and interest rate markets an opportunity to also find some equilibrium as is evidenced by the subsequent rally in equities.
As we all know, crude’s collapse over the past eighteen months has weighed heavily on markets as the impact on earnings and concern over global demand and deflation have fueled a correction in equity markets. However, now that it is increasingly apparent that crude has put in a bottom, and OPEC along with other producers have come to terms with current pricing, crude has the potential of helping to deliver on the Fed’s long sought after goals for inflation.
The Federal Reserve has long made it clear that the two key prerequisites for further rate normalization are near full employment and core inflation at 2%. The employment goals have “officially” been established and met with the official unemployment rate now standing at 4.9%. Additionally, most economists would agree that the likelihood of the unemployment rate reaching 4.5% this year is very achievable. With crude’s uneven and volatile rise from the bottom established on February 11th, inflation should hit escape velocity at 2%, if not higher, in the months to come – if crude remains in a constructive price pattern. That eventuality will provide further context for the Fed as it looks to normalize rates. Increasingly, an additional move by the Fed to raise in June will be expected by markets.