A US stock market, already on edge from a hawkish Federal Reserve and a conflict between Russia and Ukraine, now has another worry: higher oil prices.
US crude prices stand at about $91 a barrel after surging some 40 per cent since December 1 and this week touched their highest level since 2014. Prices for Brent crude, the global benchmark, are near seven-year highs.
Rapidly rising oil prices can be a troubling development for markets, as they cloud the economic outlook by increasing costs for businesses and consumers. Higher crude prices also threatens to accelerate already surging inflation, compounding worries that the Fed will need to tighten monetary policy to tamp down consumer prices.
“The stock market would really run into trouble if we went north of $125 per barrel and stayed there for a while because that would overheat high levels of inflation," said Peter Cardillo, chief market economist at Spartan Capital Securities.
"That means that the Fed would have to be a lot more aggressive and that certainly would not be a pleasant scenario for the stock market."
Rising tensions between Russia – one of the world’s largest oil producers – and Ukraine recently helped drive the rally in oil, which had been supported by a recovery in demand from the coronavirus pandemic.
Capital Economics analysts said this week that crude oil and natural gas prices would rise if the situation between Russia and Ukraine escalated "even if they fall back relatively quickly as the dust settles".
Elevated oil prices contributed to the rise in US inflation, which grew at its fastest pace in nearly four decades last month. While overall consumer prices rose 7.5 per cent year-on-year in January, the index's energy component rose by 27 per cent.
Each "sustained" $10 increase in the price of a barrel of oil adds about 0.3 percentage points to the overall consumer price index, on a year-over-year basis, according to analysts at Oxford Economics.
"The largest impact of higher oil prices is on consumer price inflation and it adds further to the pressure for the Fed to be more aggressive," Kathy Bostjancic, chief US financial economist at Oxford Economics, told Reuters.
The benchmark S&P 500 is down more than 8 per cent this year while the yield on the benchmark 10-year Treasury note has risen by 40 basis points to more than 1.9 per cent. Investors are pricing the Fed funds rate to rise to more than 1.5 per cent by the end of 2022, from near zero now, according to Refinitiv's Fedwatch tool.
Rising crude is already pushing up costs for businesses and drivers. The national US average for gasoline recently stood at $3.48 a gallon, automobile group AAA said this week, up 18 cents from a month earlier and 98 cents from a year ago.
As gasoline prices rise, investors are monitoring trends for consumers, whose spending accounts for more than two-thirds of US economic activity.
Data on Wednesday showed US retail sales increased by the most in 10 months in January, but last week's consumer sentiment reading came in at its lowest level in more than a decade in early this month.
"The risk is that if gas prices at the pump start going up that means less discretionary spending for consumers at a time when a lot of their fiscal benefits from the last couple years are fading," said Michael Arone, chief investment strategist at State Street Global Advisors.
Investors are gauging the effect of higher oil on companies’ earnings. Typically, rising oil prices are estimated to lift overall S&P 500 earnings by about $1 a share for every $5 increase in the price of crude, according to David Bianco, Americas chief investment officer at DWS Group.
Benefits to energy firms outweigh the drag on earnings of airlines and other companies potentially hurt by higher crude costs. That amounts to about 0.4 per cent of total S&P 500 earnings expected for 2022.
The S&P 500 energy sector is up 22 per cent so far in 2022, while fund managers in the latest BofA Global Research survey reported their highest allocation to energy stocks since March 2012.
But with oil prices already near seven-year highs, and energy stocks comprising a far lower share of the market than a decade ago, those slim bottom-line benefits may be overshadowed by inflation worries if crude keeps charging higher, some investors said.
"Higher oil prices, without a recession, raise S&P profits," Mr Bianco said. "But not as much as it used to and you definitely don’t want this happening when the Fed is fighting inflation."
