How can OPEC throw a wrench in the Fed's plans to cool down inflation while softening the fall of the U.S. economy?
Let's take a look.
First, we need to step back and see the big picture. Liquidity has been paramount in distorting all asset prices over the past 15 years since the Great Financial Crisis. Central banks, who were too scared and unwilling to get to the bottom of the problem, kept printing more money to plug any leak in their economies. Today we are in a situation where debt-to-gross domestic product is the most extended since WW2. The Fed balance sheet has ballooned from $2 trillion to over $8 trillion, of which $5 trillion was added since Covid.
Investors have gotten so used to just buying the dip. It's been a strategy that has worked since 2008, so why fight it now? But all great things, even economic cycles, come to an end. Certainly the largess of central banks is coming to an end.
Today the Fed is grappling with an economy that is so unproductive yet is seeing such sticky wage inflation, that it has its hands tied. The mechanics of the past cannot work today. If yet another trillion or so in quantitative easing is produced to support the economy, inflation will go above and beyond 4% for the long haul. Inflation is a much worse problem than lacking productivity. Today the market is screaming for more liquidity as the property market consumer has run out of stimulus to keep this cycle going. But markets are only off about 10% from all-time highs -- is that really a serious enough danger for the Fed to throw in the towel today just because "you only live once" day traders are not able to make money like they did in 2021?
The U.S. government threw so much fiscal and monetary money at the economy, it takes about a good year for it to filter off. Today we are seeing the ISM manufacturing index fall, but services sector inflation holds up. The U.S. consumer has been quite strong, thanks to Bidenomics. It has been able to max out its credit card and use savings along with the government stimulus to pay for pricey lifestyles. But that is all coming to an end, as many Americans have exhausted their savings.
Today the monthly mortgage payment based on a median existing home is now at a record $2,322 per month. This is double the $1,200 peak seen in 2008. Roughly one third of all homes for sale in the U.S. are new construction. Even pre-2008, the largest housing bubble in history, only saw a peak of 17% of supply being new homes. There are no new buyers as they cannot afford the new mortgage rates of 7% or more on 30-year, and those that have a fixed one now, do not want to sell their homes to move. The commercial real estate worries are in serious risk of spilling over into residential as the U.S. consumer is strapped. In September, the student debt moratorium comes to an end making their wallets even tighter.
As much as the Fed would like to print, yet again, it cannot. Core consumer price index inflation is averaging close to 3.5%-4%. It is surely coming down, but the Fed can't take its foot off the pedal too soon. The Fed has been very clear in saying that it does not see a reason to remove the rate-rising stance as the labor market is strong. It still needs to kill inflation. But the market keeps doubting it and buying long duration assets in hopes that they cut. It never works that way. There is a reason why the saying goes, "Don't fight the Fed."
But now OPEC, which is mostly Saudi Arabia, is doing just that. It has extended its one million barrel per day cut through the end September, yet oil is unable to rally. The flawed logic of trying to keep the price stable and high until the eventual demand recovery in the fourth-quarter is going to backfire. As we know, recessions are needed to get prices back in check to see demand eventually recover. But if energy is held up high for too long, it will keep inflation up for much longer, meaning the Fed will not be able to cut as much as it needs or when the time comes.
If one is too short-term in his thinking, then one loses sight of the bigger picture. But then again, OPEC is too scared to lose its key resource that yields all the revenues it needs for future growth ambitions, but it's only making matters worse and delaying the inevitable.