Oil Keeps Flowing Uphill, China Keeps Sliding Downhill

It is going from bad to worse at a pace where you can feel the change every day now. Oil has rapidly risen to a price level where it is changing trading strategies on Wall Street, and China has sunk to a level that it’s making businesses question whether to do business in China at all.

Oil’s on fire

Brent Crude touched $95 per barrel, and the news today is taking note of how that is changing entire markets:

The non-stop rally in oil is forcing investors to rethink their bets across global markets.

Airline stocks, currencies of oil-importer nations and bond yields are just a handful of the asset classes already starting to reflect the reality of Brent at $95 a barrel. Meanwhile, strategists from Goldman Sachs Group Inc. and Barclays Plc have rolled out macro reports telling clients how to trade the energy price shock.

And, of course, it is, as I said, affecting the decisions of central banks over their inflation policies; or, at least, markets are assuming it will be:

With a trio of central bank meetings still to come this week, energy and its potential impact on inflation and economic growth has become the biggest conversation on Wall Street.

“One of the most obvious impact would be for oil prices to derail the trend of disinflation and prevent central banks to cut rates as early as hoped by markets.”

Markets were entirely foolish to have speculated that central banks would be cutting interest rates any sooner than they had telegraphed. The Fed has clearly stated it has no intention of lowering rates before the end of 2024 but the market keeps wanting to get high on the fumes of hope.

The rising price of oil is also pushing the dollar higher on foreign exchanges, which is pounding the yuan harder in its now all-but forgotten attempt to supplant King Dollar.

Energy is driving a wedge between the foreign exchange of oil importers and exporters. “Almost all currencies weaken against the dollar as a result of a supply oil shock,” wrote Themistoklis Fiotakis, head of FX research at Barclays.

With oil doing so well, the big money on Wall Street is moving over to energy producers that have oil to sell. And, finally, mainstream media is starting to report that the rising price of oil is posing a big problem for the Fed’s “soft landing.” Days ago the story was summarily dismissed as “transitory” in some financial stories; but this is a tough battle the Fed has seen before, although it is far enough back to likely rely on body memory as to how to deal with it — deep instinctive reflexive actions, rather than anticipatory fine tuning.

The Federal Reserve is confronting a familiar nemesis as it tries to pilot the economy into a rarely-seen soft landing: rising oil prices.

Surging energy costs played a role in tipping the US into recession in the mid-1970s, as well as the early 1980s and 1990s, as they drove up inflation and robbed consumers of purchasing power.

At least, they are saying now what some were trying to deny last week.

“The run-up in oil prices is at the very tip top of my worries at this point,” said Mark Zandi, chief economist at Moody’s Analytics. “Anything over $100 for any length of time and we’re going to be very sick.”

We are now getting awfully close to that point.

Supply shocks such as climbing oil prices present the Fed with a quandary as they simultaneously boost inflation and curb economic growth, leaving policymakers at times uncertain about whether to tighten or loosen credit in response.

The question is becoming particularly salient now, as the central bank debates whether or not it should raise its benchmark rate once more this year before going on hold for an extended period….

Traditionally, the Fed has tended to play down the impact of higher oil prices on inflation, viewing the effect as transitory.

And, so, inflation is back on, and now you are reading about it in more places than just here, where I try to tell you the news before it happens, and now some are starting to question whether it is all transitory or not:

In August, consumer prices jumped 0.6%, registering the fastest monthly increase in over a year. Higher gasoline costs accounted for more than half the advance….

Policymakers will be on high alert for a gasoline-driven rise in inflation expectations in particular, as they fear that could lead to a more broad-based increase in prices….

What Bloomberg Economics Says...

“Oil prices pushed up overall inflation in August and have surged toward $95 a barrel, threatening to heat up inflation yet again. The Fed will be keen to look though these gyrations at the Sept. 19-20 FOMC meeting — especially with consumer inflation expectations having come down — but will stay resolute in the inflation fight….”

“This could cause a significant reversal in headline inflation, forcing the Fed to take more aggressive action than I think investors are focusing on.”

Exactly. At last, it is being said. There is no doubt in my mind that energy is going to keep pushing up inflation, but the problem for the Fed is two-fold because higher energy prices also slow the economy more than the Fed has already slowed it, and the Fed has no control over how long those energy prices last and, therefore, on how far rising energy costs may push the economy below the Fed’s soft-landing hopes.

Businesses will raise prices as energy costs rise, and consumers will buckle down to stretch their budgets, and that makes this the critical juncture where it all gets really dicy for the Fed, looking like a slide into a stagflationary recession as we had back in the late seventies/early eighties.

Saudi Arabia may be tempted to ease away from its production cuts if oil rises above $100 a barrel because they, too, know that at that magic level, economies start falling apart and demand for oils falls away …

But fine-tuning the market may not be easy. Even if Saudi Arabia and Russia relax their supply curbs in early 2024, oil inventories will be severely depleted, leaving prices vulnerable to shocks, the International Energy Agency said in a Sept. 13 report.

The China syndrome

China, meanwhile keeps falling harder, and there seems to be no end in sight to its plunge. Many businesses are now questioning their position in China. Does it even make sense for them to keep trying to do business in this reversionary economy that has settled back toward they dusty days of old dictators that predate China’s modern economy?

We saw China revert to its old ways during President Xi JinPing’s zero-Covid lockdowns where leaders who hold themselves to the level of gods think they can dictate economic policies without worrying about cause-and-effect they do not control. They will simply decree a reopening, and everything will respond to that command, as it all did to the forceful demand for full citywide closures, and everything will be fine again.

Not so:

Even after the ending of COVID curbs, which weighed heavily on both revenues and sentiment in 2022, the percentage of surveyed U.S. firms optimistic about the five-year China business outlook fell to 52%….

This was the lowest level of optimism reported since the AmCham Shanghai Annual China Business Report was first introduced in 1999….

"By the time we did this year's survey a lot of the illusions had fallen away that we would see a sustained rebound in economic growth (post-COVID)."

If only Xi would have read here, he would have known where his austere lockdowns were taking his nation. But alas.…

Of course, it was not just zero-Covid. There are many ways that supreme dictators can steer their economies more directly than democracies, and those may be the envy of Western nations at times when they are able to drive the economy upward, but they can rarely steer away natural cause and effect; and misplaced policies can have a lot of unintended effects that don’t just go away when you change the policy, while leaders that no longer believe they have to accept natural laws of cause and effect may be slow to realize they need to steer a different course.

Concern over the transparency of China's regulatory environment also grew, with one third reporting that policies and regulations towards foreign companies had worsened in the past year, though many respondents pointed to U.S. government policy rather than China's when asked about pressure to decouple.

Did the Chinese actually think the US wouldn’t fight back and that it couldn’t win that fight? As the dollar now steamrolls over the yuan, they are learning a painful reality. It was the US that made China rich, but dictatorial policies in China are turning businesses away from China, and trade wars started by Trump also broke down supply chains, making US businesses leary of holding all their eggs in the China basket. Then Xi pushed it all of a cliff with what I called his Xiro-Covid policies, just when supply lines were about to rebuild. And that was the end of that.

So, how does that play out? It plays out with other national competitors to China acing China out, and US businesses go to them to diversify their supply lines, which makes those losses business that is not ever returning to China … or, at least, not for a long time:

This echoed a report published by Rhodium Group last week, which said that India, Mexico, Vietnam and Malaysia were receiving the vast majority of investment U.S. and European firms were shifting away from China.

You bite the hands that made you very, very rich for many years, and eventually businesses say, “We don’t have to keep putting up with things like dictator Covid policies,” while investors say, “We don’t have to put up with dictator banking decrees to save the yuan.” And the money moves, and the Chinese lose.

They would never have gotten rich without major market shifts in the US and Europe that sent business oversees to find cheap labor, but eventually those businesses found cheap labor isn’t always cheap. There are strings attached that may not be good for American businesses in China, such as a dictatorial business climate that can swing at the ding of a Xi Jinping bell. Then the Chinese people and businesses you partnered with in order to do business in China say they don’t need you anymore, and they become your competitor after you give up your trade secrets to work with them. And there is always that typical lack of transparency with businesses and government in China so no one really knows what they are dealing with.

You can hear all about how bad it is looking for China’s full-on collapse in a video for subscribers: “Don't Be Surprised by China's Collapse.” If this continues long, Tiananmen-Square types of civil revolt will come soon. Mark my words because we will be coming back to them, perhaps sooner than you may think.