Written by Lance Roberts, Clarity Financial
The big surprise on Friday was the expected reversion in both oil prices and interest rates. As I showed earlier this month, with everyone on the same side of the boat, it was only a function of time until a rising dollar and interest rates collided with oil prices.
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“Of course, the cycle of rising oil prices leading to increased optimism which begets bullish bets on oil continues to press prices higher. However, it is also the exuberance which has repeatedly set up the next fall. As shown below, bets on crude oil prices are sitting near the highest levels on record and substantially higher than what was seen at the peak of oil prices prior to 2008 and 2014.”
All that was lacking was a catalyst to spark the reversion. Once again, we saw Bob Farrell’s rule #9 in action:
“When everyone agrees, something else is bound to happen.”
The massive positioning was not only in oil, but short bonds as well.
“Previously, such record net-short positioning has been more indicative of peaks in the interest rate cycle as opposed to the beginning of higher rates. You can see this more clearly if we strip out all of the positioning except those periods where net-short contracts exceeded 100,000.”
“With the net-short positioning on the U.S. Treasury at records, the net-short positioning on the Eurodollar has also reached a record. Once again, what we find is when the net-short positioning starts to get overcrowded, that too has been a good indication of a bottom in bond prices (or a peak in rates.)”
On Friday, “something broke” as rates fell by 1.68% and oil plunged by 4.51%.
This was expected as I penned last week:
“Energy led the advance last week as oil prices pushed to $70/bbl. As we noted previously, with record long positions in oil future contracts, the energy sector extremely overbought and extended, some profit taking from the recent advance, which has only recovered the sector back to January’s levels, is advisable.”
The more important problem is the rise in inflationary pressures, which has had the Fed focused on lifting rates further. The problem is the bulk of the “rise” has been driven by rising oil prices. Unfortunately, rising input costs detract from disposable household incomes on an already cash-strapped consumer. This is the wrong type of inflationary rise which negatively impacts economic growth. As opposed to rising prices driven by rising demand, cost-push inflation simply eats away at discretionary incomes reducing consumptive spending which is 70% of economic growth.
