Traders price in a 25 bps move in rates

Global crude oil prices jumped nearly 5% Sunday on news that non-OPEC producers have agreed to reduce production in an effort to buttress the recent OPEC announcement aimed at lifting global energy prices. The recent dramatic trade higher in crude pricing, that was the result of the OPEC deal, has in effect been thrown an accelerant in the process. This weekend’s announcement has major near term implications for not only energy prices but also equity prices and for monetary policy.

WTI crude futures ripped 4.8% higher in the overnight while US equity futures, fueled by expectations of trade higher in the all-important energy sector, reversed course, turned higher and are pointing to a positive open and a continuation of our powerful, broadly based post election rally. As we have discussed, financials have clearly been the outperforming sector since the elections (XLF +18.80%) but with the non-Opec news out yesterday it would be reasonable to expect a rotation within the market into energy today and in coming sessions. That is not to say that financials don’t have more room to run, they do. However my suspicions are that the energy sector will now assume a leadership position into year-end as US equities continue their move higher. The Energy Select Sector SPDR ETF (XLE) has risen 10.50% since the election and though that is dramatic for a four week period, we may see the space leg higher in coming days.

Is it possible that the financial sector could continue its blistering pace of price improvement? Yes, but we may some weakness before Wednesday’s FOMC announcement. Traders have priced in a near 100% certainty that the FOMC will move on rates this week. In that event, look for the financials to continue to move higher though a large percentage of the year’s gains for the space are in the books. More modest gains are the likely path forward in the financial sector.

Higher energy prices as a result of the OPEC and non-OPEC agreements may well be the straw that breaks the back of the monetary policy stalemate which has kept rates unchanged for twelve months. The direct correlation between higher energy prices and inflation is undeniable and powerful. In the event the production agreements hold and as a result crude prices rise, inflationary pressures within the US economy will become significantly more present. The Fed knows this. With near full-employment, modest wage gains Y/Y, and rising energy prices, the Fed will be forced to become increasingly more proactive on rates. As we all know, last month’s FOMC Minutes clearly indicated that several Fed officials were on the fence in terms of raising rates. The news this weekend out of the oil patch will likely force those that have remained on the fence for twelve months to jump off.

flickr photo: pasa47