Financial markets have been fired up over the past 2 years via the arrival of high volume computerised trading. This now dominates market action. And until recently, the US Federal Reserve was happy to finance this activity, via its $600bn QE2 programme.
The Fed’s aim was to generate inflation, and so avoid the risk of following Japan’s deflationary path since 1990. ‘Making sure it doesn’t happen here’ was, after all, the title of the speech that catapulted current Fed Chairman, Ben Bernanke, into the limelight in 2002.
But, of course, the Fed also has a specific mandate to control inflation. And politicians know that voters become upset when energy and food prices get out of control. Thus it seems unlikely that the Fed will be allowed to proceed with QE3, when QE2 ends next month.
Significantly, therefore, we are now seeing the first divergence in 2 years between stock market performance and that of crude oil. As the chart shows, the main US stock index, the S&P 500 (red line), has failed to follow Brent crude oil (black line) higher since March.
The divergence is now quite striking. Brent is up 50% since January 2010, whilst the S&P 500 is ‘only’ up 23%. This suggests that equity investors have already begun to recognise that something very important may have changed in financial markets.
If it has, and liquidity is really going to be withdrawn, then crude oil prices could end up very much lower, as traders exit the market. As the blog warned back in October – once the QE2 Lifeboat party has ended,
“and the computers have been shut down for the night, it will be the real world of the chemical industry that will have to pick up the pieces.