Oil shock implications

Expectations of a rate cut in the March 18th FOMC meeting are almost gone. A partial victory lap for J Powell which has seen his prudent approach to inflation concerns validated by the war started by his main critic. If you look at the chart below, you can see that PCE, the Fed’s preferred measure of inflation, will go up 20 bps if there is a 10% shock in the price of oil. It’s almost 50% up YTD. Gasoline will be the main transmission mechanism, but not the only one. The implications can be dire: the private credit market is mostly based on variable rates, with a spread over SOFR, which is directly linked to Fed Funds. Loans will not reset down, putting more pressure on issuers, which in turn put more pressure on Private credit and leveraged loans Managers, squeezed by outflows from investors that are concerned about the return OF their money, not the return ON their money. It also affects Commercial Real Estate, and the CMBS market. It also affect the rate of the 30% of U.S. debt that is parked in Treasury Bills, which will not reset lower, putting pressure on the government budget. The only good news to add to this equation is that there is a huge amount of cash parked on Money Market funds that will continue to earn interest at current rates. But that may not last forever. For instance, Berkshire Hathaway has announced it will buy back some of their own stock with part of the $400Bn in cash it hoards. How long can the economy hold all the pieces together?

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