What will it do with Oil at $100?

Outlook

We get the US PMI today after a nice set of PMI data from the eurozone, but we say the information will get thrown out the window in favor of the more pressing and dramatic moves in oil, yields and central bank speculation.

In the eurozone, the flash July PMI was stronger than expected, with manufacturing at 52.0 from 51.4 and services up 51.6 from 49.4. This takes the composite to 51.9 from 50.0 in June. What will it do with oil at $100?

The market has pressure from too many directions at once and risks blowing its top. We have already been through the tariff ordeal and know for sure it raises inflation fear, although supply chains did turn out to be more resilient than had been forecast at the beginning of the first round.

The doubling of oil supply chokepoints with the Houthis now in the game as a proxy for Iran is another inflation-driver. It’s politically infuriating and terribly sad at the same time. As we wrote some time ago, the Yemenis don’t have indoor plumbing and they are so deluded they want to take on the biggest military in the world? This is religious fanaticism to the nth degree. Lemmings and cliffs, or a Pied Piper named ayatollah. 

Inflation coming from two directions inevitably leads to the bond market throwing a fit. As noted above, we are getting historic highs in yields. For the US and UK, the inevitable rise in the government deficits may turn into a crisis, if not as dramatic as Truss and the lettuce. Bottom line, the bond gang is getting upset and turning vigilante, which has the potential to bring some unhappy surprises. 

Now we need to wonder what central banks are going to do. The ECB decided to hold for the moment and that’s what is expected at the BoE and Fed next week, but questions about future meetings are piling up. We expect Bloomberg to present an article any day now pointing out that an inter-meeting rate is possible, too, with examples.

Central banks supposedly do not consider equity markets when making rate decisions, but this is an instance when the driver is inflation and that means they can’t pretend not to see the effect. They also can’t avoid the responsibility to maintain financial market stability, the now-unwritten mandate.

Bottom line, inflation is going up and it’s the central banks’ job to apply the brakes. No matter how Mr. Warsh re-jiggers the data, which is probably not a bad idea, oil at about $100 is inflationary, period and full stop.

Press reports say the probability of a Fed rate hike is higher. The CME FedWatch tool shows that the probability of a hike next week is now 33.7%, from 12.8% a week ago. As for September, the majority are betting on no change with 23.3% seeing a hike and 20.4% seeing a cut. A cut?

Forecast

Back in March, we wrote that the key to financial markets was the Strait. Now we add the Red Sea, the only other viable route for Saudi oil.

This is a geopolitical disaster. Trump “should” start the all-out war this weekend if he feels the need to fix markets.

Friday is a scary day when the market just did a sizeable reverse turn. We are pretty sure we will still get position-squaring and position-paring, as usual on any Friday, but how far will that take prices? Those who see continuation the following week will want to hang on to some portion of their dollars, especially if they think, as we do, that Trump will go for all-out war.

But then second thoughts. After some panic and a spike high, all-out war is a weirdly good thing for those who want the dollar to return to a decline. War does have to end sometime and the famously impatient Trump  will want it over PDQ. We could get a sell on the rumor effect.

Something along the same lines is trader fatigue. Too much worry and anxiety can send traders into squaring mode.

Trump will act sometime soon because he is looking like a loser with every passing day, bravado or not. He thinks the stock market is about him, so the current sell-off is a personal insult. His TreasSec might be whispering in his ear that yields this high can make the deficit much, much worse. Mr. Warsh can’t jigger the data to make the case that inflation is lower than we think or is about to fall, hence no rate cut and solidifying sentiment among the govs that a hike is needed.

Trump would prefer a weak dollar, anyway but the dollar is not near the top of his list these days.

So gird the loins for a fight or retreat under the bed? We feel like turning out the lights and hiding.