‘Correlation trade’ keeps energy costs rising

Chemical companies, Consumer demand, Currencies, Economic growth, Financial Events, Oil markets

WTIvS&P Feb11.pngAfter the events of the past few days in Egypt, it seems timely to look at the latest state of the ‘correlation trade’ currently ruling global financial markets. As the chart shows, prices for WTI crude oil (green line), continue to follow those of the S&P 500 (blue) in most remarkable fashion.

The trade is led, as discussed yesterday, by the US Federal Reserve’s programme of quantitative easing (QE). It has now spent ~$380bn of its latest $650bn tranche. Both the S&P 500 and WTI are up over 20% since this was first announced last August.

‘Don’t fight the Fed’ has always been one of the main rules of stock market investment. But its mandate from Congress does not mention support for asset prices. It is supposed to aim for “maximum employment, stable prices, and moderate long-term interest rates“.

Against these targets, the Fed’s current policies seem wildly unsuccessful:

• The 9.4% US unemployment rate remains at record levels, with 14.5m jobless. The wider U-6 measure, including discouraged workers, is near 17%.
• Similarly, inflation is now at 1.5%, with energy up 7.7%. And worryingly, 43 million Americans are now on food stamps, 1 in 7 of the total population.
• Mortgage interest rates have increased since QE2 was announced, due to inflation fears, putting more pressure on an already weak housing market.

Thus the Fed is actually creating new problems, rather than solving the ones it is supposed to target. Plus, of course, from a chemical industry viewpoint, today’s ever-higher feedstock costs must be impacting final demand globally.

The Fed should know that there has never been a time when the global economy was able to operate successfully at today’s oil price levels. It is wishful thinking for it to continue with current policies, in the hope that ‘this time, it is different’.

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