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Marketmind: Restive markets simmer after oil sideswipe

[September 06, 2023] A look at the day ahead in U.S. and global markets from Mike Dolan

Roiled by an oil price spike and dour August business soundings, world markets struggled again on Wednesday as they assessed a messy disinflation picture that complicates prospects hopes for peak interest rates.

With this month's Federal Reserve meeting hoving into view, Tuesday's decision by Saudi Arabia and Russia to extend voluntary oil supply cuts to year end sent international crude oil prices to more than $90 per barrel for the first time this year.

That's a moment in the whole disinflation story as it virtually wipes out the negative annual base effect so powerful this year in helping drag headline inflation rates back down.

At the very least, it suggest the low-hanging fruit on the disinflation path may already have been picked, and central banks may have to battle harder from here to get inflation down to 2% goals. And it may mean headline rates tick up again this month.

U.S. Treasury yields have been spurred again by energy price developments, alongside pressure from a swathe of new corporate debt issuance this week that sees hedging activity in benchmark bonds. U.S. 10-year yields hovered near two-week highs just under 4.30% on Wednesday and stocks fell across the world again.

The Bank of Canada is, on Wednesday, the latest G7 central bank to review policy. It's expected to stand pat on rates for now but leave options open for further hikes if necessary.

The more complicated inflation picture comes against the week's downbeat business surveys from Europe and Japan. U.S. service sector equivalents for August are due later on Wednesday.

The big fear for investors is that what looked like an emerging 'goldilocks' scenario of cooling inflation and resilient growth starts to shape more like the 'stagflation' of sticky price gains and crumbling demand.

For now, futures market thinking on the Fed's Sept 20 meeting remains unchanged - with pricing still suggesting the U.S. central bank's tightening campaign is over.

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., July 20, 2023. REUTERS/Brendan McDermid/File Photo

That take was reinforced overnight by a New York Fed study that suggested the theoretical 'neutral' interest rate keeping the economy at equilibrium continued to fall in the second quarter.

NY Fed researchers said their 'R-Star' estimate for the second quarter ticked down to 0.57% from the first quarter’s 0.68% - cooling post-pandemic speculation that the Fed may be inclined to revise up its view of the inflation-adjusted, long-term sustainable interest rate.

And that new estimate would tally to the nominal long-term policy rate Fed officials have most recently pencilled in at 2.5% - less than half the prevailing policy rate.

Elsewhere, slightly calmer bond markets saw the dollar come off the boil too and its DXY index edged back from six-month highs hit on Tuesday.

The energy picture saw Asia and European bourses in the red again, with Japan's Nikkei bucking the trend. Wall St futures were also marginally lower again ahead of the open and the VIX volatility gauge a touch higher at 14.

Events to watch for on Wednesday:

* U.S. August ISM and S&PGlobal service sector business surveys, U.S. July international trade, Canada July international trade

* Bank of Canada policy decision

* Dallas Federal Reserve President Lorie Logan and Boston Fed President Susan Collins speak. Fed publishes Beige Book of economic conditions

(By Mike Dolan, editing by John Stonestreet; mike.dolan@thomsonreuters.com. Twitter: @reutersMikeD)

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