High energy prices increase the risk that inflation will remain elevated for longer, limiting room for monetary easing. If oil prices stay at current levels, higher costs could feed through to transportation, production and corporate margins. At the same time, yields above 5% raise the cost of capital and make bonds an increasingly competitive alternative to equities.
Growth stocks remain particularly vulnerable, as their valuations rely more heavily on earnings expected further into the future. Higher discount rates reduce the present value of those future cash flows, putting additional pressure on the technology sector and the Nasdaq.
The oil market is adding to these concerns. The situation around the Strait of Hormuz remains unresolved, while further attacks on Saudi infrastructure are raising fears over supply. The risk of disruptions along the Red Sea route also limits the availability of alternative shipping routes. In such a tight market, further supply disruptions could quickly push prices even higher.
This is why the Fed meeting will be the key event for markets. Unlike earlier expectations, investors are no longer pricing in rate cuts. Instead, the market has largely priced in a 25-basis-point hike, meaning the decision itself may not come as a major surprise. The key question is whether the Fed will actually deliver the hike and, more importantly, what its communication will look like afterwards.
Investors will be looking for clues on whether the hike is a one-off response to inflationary pressure or the beginning of a longer period of tighter monetary policy. With oil above $100 and 10-year Treasury yields above 5%, any signal that further hikes could follow would put additional pressure on Wall Street. A more cautious tone from the Fed, however, could quickly unwind part of the market’s hawkish expectations.
Source: XTB Research
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