Revisiting Last Week’s Selloff – It’s All About Oil, The Dollar And Inflation

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Every weekend I write a client note in which I attempt to summarize the week’s action and highlight significant events.  As I was writing it last night I was struggling to make sense of the huge selloff we saw last Thursday and Friday.  I tried and tried to put the pieces together to explain Thursday’s huge selloff.  But I couldn’t do it to my satisfaction. 

I ultimately just decided it was a confluence of a bunch of different causes.  The Wall Street Journal’s market column mentions the $5 jump in oil, Goldman Sach’s downgrade of Citi, GM and other financial and auto companies as well as negatively received earnings reports from Research In Motion (RIMM) and Nike (NKE).

But two articles in today’s Wall Street Journal (“Oil Takes Notice of Monetary Policy” (subscription required), “Fed’s Priority Is Likely to Be Oil-Price Shock” (subscription required)) made me realize that a lot of the move was also about the Fed decision on Wednesday and the reaction to it in currency, commodity and ultimately equity markets

After talking tough on inflation in the weeks leading up to their decision last Wednesday, the Fed didn’t really follow through.  They left interest rates unchanged but didn’t really give inflation the emphasis markets had been led to expect.

As a result, the dollar began to tank after the decision ($ Euro 1 Week Chart) which caused a surge in oil prices (gold too) and a selloff in equities.  BeSpoke Investment Group put up a post this morning that clearly shows the inverse relationship between stocks and oil last Thursday and Friday: “It’s All About Oil”.

In other words, the action last Thursday and Friday was reminiscent of the huge selloff on Friday June 6, 2008 which I summarized in a post titled “Job Losses = Dollar Drop = Oil Rise = Stock Market Crash”.

The take away here is that the weak dollar and consequent surging oil market is what’s really driving things the last month or so.

Paradoxically, a more hawkish Fed statement probably would have resulted in a better outcome for the stock market but the Fed feared it would result in a worse one which is why they avoided it.

All of this suggests that the thing to watch is oil

Further, if the Fed would step up and either raise rates a quarter point or at least be real clear that inflation is the #1 priority, this would support the dollar and level a blow to the oil market with positive consequences for stocks.

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