Rising Brent Crude Prices Could Tighten US Interest Rates, Warn Economists

Once again in the spotlight, Brent crude oil prices, are at their highest levels this year. This is largely due to anticipated further reductions in oil output from major exporting countries.

In a surprising move, Saudi Arabia has hinted at even more significant production cutbacks in the near future. This comes after Saudi Arabia and Russia, the main forces behind the current price increase, extended their commitment to cut oil production by a total of 1.3 million barrels per day.

Oil’s Production Cuts To Send Shockwaves

As reported by The New York Times, Commodities analyst Nadia Martin Wiggen from Pareto Securities, speaking to Bloomberg, voiced the possibility of Brent crude reaching the coveted $100 per barrel mark, a level reminiscent of the post-Ukraine invasion era.

Costlier oil may send shockwaves through higher interest rates. Economist Jorge León of Rystad Energy, contacted by the NY Times, asserts that higher oil prices will only increase the likelihood of more tightening, especially in the U.S., to curtail inflation.

Michael Tran, managing director at RBC Capital Markets LLC, told Bloomberg that “the Central Bank of oil” is exerting heavy pressure on short sellers, referencing the regained pricing power of oil producers.

Warren Patterson, head of Commodities Strategy at ING Groep N.V., points out that this extension leaves the market with a deeper-than-expected deficit in the fourth quarter of 2023. However, concerns over demand and rising Iranian supply could limit price increases. ING forecasts that Brent oil will keep averaging $92 a barrel for the remainder of 2023.

US Concerns And Possible Solutions

The U.S. is particularly sensitive to this price increase, with the Biden administration striving to avert $4-a-gallon gasoline. Gas prices are already at their highest seasonal level in over a decade, and renewed inflationary pressures could strain consumers and disrupt global central bank efforts to quell inflation.

Global leaders may seek relief from sanctioned oil exporters, with Iran’s exports surging since Saudi cuts began. Venezuela, also under sanctions, looks to Beijing for help in reviving production.

Market Impact

Investors have responded by offloading government bonds, including 10-year Treasury bills, as tracked by US Treasury 10 Year Note ETF UTEN, amid concerns that central banks will need to remain hawkish on interest rates to counter the inflationary impact of rising energy prices. A flurry of corporate-bond issuances this week has further roiled the debt markets.

On the stock market front, energy-related companies have materially outperformed the rest of sectors recently. The Energy Select Sector SPDR Fund XLE is up 15% over the past three months, a performance that outpaces the SPDR S&P 500 ETF Trust SPY threefold and exceeds the Invesco QQQ Trust QQQ of the Nasdaq 100 by more than double.

Chart: Energy Stocks Have Soared This Summer, Leaving The Rest Of The Market In The Dust