When Oil Rises,
Everything Changes
Oil is one of those markets that can have a much bigger influence on financial markets than its price chart might suggest.
When crude moves sharply higher, the impact can quickly spread into fuel prices, inflation expectations, interest rates, currencies, bonds, gold and equities. The further the move continues, the more likely it becomes that traders in other markets start paying attention.
That is what makes the recent move in oil particularly interesting.
Brent crude moved back above $100 a barrel in late September as concerns around Middle East tensions and the Strait of Hormuz increased. Prices have since pulled back from those highs as some Gulf exports recovered, but the underlying risks have not disappeared.
So rather than asking simply where oil goes next, it is worth looking at what a sustained rise in oil prices could mean for the rest of the market.
1. The trigger: Why is oil back above $100?
The latest move in oil has been heavily influenced by developments in the Middle East and concerns about energy supplies.
The Strait of Hormuz is particularly important because of the enormous amount of oil and other energy products that pass through the region. Any disruption, or even the possibility of one, can quickly change how traders price the market.
There is an important distinction here.
Oil prices do not need to rise because supplies have already been completely cut off. Markets can move well before that happens.
If traders believe shipments could be delayed, insurance costs could increase or infrastructure could be affected, they may start pricing in a higher risk premium.
That was one of the key factors behind the sharp move in crude towards the $100 level.
There are also differences between crude exports and refined fuel supplies. While some Gulf crude exports have recovered, refined fuel exports have remained more constrained because of refinery disruptions and transportation risks.
For the market, that means the supply situation is not simply a case of everything returning to normal.
And this is where the oil story starts moving into the wider economy.
2. The first domino: Inflation
Oil has a habit of showing up in places where you might not immediately expect it.
The most obvious example is fuel.
When crude becomes more expensive, producing and transporting fuel can become more expensive as well. Higher transportation costs can then affect companies moving goods around the country or across borders.
Those costs can eventually find their way into the prices businesses charge consumers.
It does not happen instantly, and not every increase in oil prices turns into a major inflation problem. Much depends on how large the move is and, more importantly, how long it lasts.
But a prolonged increase in energy prices can make the inflation picture more difficult for central banks.
And that brings the Federal Reserve into the conversation.
3. The Fed dilemma: What happens when growth needs lower rates, but oil pushes inflation higher?
This is where the story becomes more complicated.
The Federal Reserve has to balance inflation against economic growth. If economic activity starts slowing, there can be a case for lower interest rates.
But lower rates become more difficult to justify if inflation is moving higher again.
Oil can create exactly that problem.
Imagine an economy that is beginning to lose momentum. Investors start expecting interest-rate cuts because they believe policymakers will want to support growth.
Then oil prices surge.
Higher energy costs begin putting pressure on inflation expectations. Suddenly, the argument for moving quickly towards lower rates becomes less straightforward.
That is one of the reasons oil has become increasingly important for interest-rate expectations.
On September 29, New York Fed President John Williams said there was no urgency for another rate increase and that policymakers had time to assess incoming economic data. He also said that, if the economy develops broadly as expected, another increase later in the year could still be appropriate.
His comments contributed to a sharp decline in expectations for an October rate hike.
The interesting part is what happens if the oil market continues to push inflation expectations higher.
The Fed may want to respond to weaker growth, while at the same time having to consider the inflationary effect of higher energy prices.
That is a much more complicated environment for markets than simply asking whether the next Fed decision will be a hike or a cut.
4. The dollar reaction
Interest-rate expectations naturally bring the US dollar into the picture.
If investors expect US interest rates to remain higher for longer, Treasury yields can rise. Higher yields can make US assets more attractive and provide support for the dollar.
We have already seen some of that dynamic playing out.
On September 29, the dollar reached a 16-month high against the euro and Swiss franc as investors adjusted their expectations around US interest rates and higher Treasury yields.
But there is another factor at work during periods of geopolitical uncertainty.
The dollar is also widely used as a safe-haven currency.
That means a geopolitical shock can create several competing forces at the same time. Higher yields can support the dollar, while increased uncertainty can also encourage investors to seek liquidity and safety.
For traders, this creates an important connection between the oil market and currencies.
A move in crude can change inflation expectations. Those expectations can influence interest-rate pricing, which can affect Treasury yields and ultimately the dollar.
And because commodities such as gold are priced in US dollars, the move in the currency can then feed back into commodity markets.
5. Why Isn't Gold Doing What Everyone Expects?
This is perhaps the most interesting part of the story.
When geopolitical tensions increase, one of the first assumptions many investors make is that gold should automatically move higher.
There is certainly a reason for that view. Gold has historically attracted demand during periods of uncertainty.
But gold does not trade on geopolitical risk alone.
Interest rates and Treasury yields matter too.
If oil prices rise and markets become concerned about inflation, investors may start expecting interest rates to remain higher for longer. Treasury yields can then move higher.
That can make an asset such as gold, which does not pay interest, relatively less attractive compared with interest-bearing assets.
A stronger dollar can add another layer of pressure because gold is priced in US dollars.
This is why the relationship between geopolitical risk and gold is not always as simple as it appears.
Recent price action has highlighted that.
Reuters reported on October 1 that gold was holding relatively steady despite a stronger dollar and elevated Treasury yields, with softer US inflation data helping offset some of the pressure from higher yields.
Gold has also shown considerable resilience despite the rise in bond yields.
That tells us something important about the market.
There can be several competing forces affecting gold at the same time.
Geopolitical uncertainty can support demand, while higher yields and a stronger dollar can create headwinds.
The result is a market that is much more complicated than simply saying that geopolitical tensions are bullish for gold.
6. And what about stocks?
Equities are where the chain reaction becomes particularly interesting.
Higher oil prices can increase costs for businesses and consumers. If those higher costs contribute to stronger inflation, investors may begin pricing in higher interest rates.
Higher rates increase borrowing costs and can put pressure on company valuations, particularly when investors are paying high prices for future growth.
But there is another side to the story.
Markets are rarely driven by one factor.
Strong corporate earnings, productivity expectations, technological developments and investor sentiment can all help support equities even when the broader macroeconomic environment becomes more challenging.
Artificial intelligence has been a particularly important theme.
Despite higher oil prices and rising bond yields, global equity markets have remained relatively resilient. Investors have continued to focus heavily on earnings expectations and the potential economic impact of AI.
That creates an interesting question for the months ahead.
Can strong earnings and AI optimism continue to support equity markets if the cost of money keeps rising?
There is no simple answer.
The longer bond yields remain elevated, the more important the relationship between company earnings and valuations becomes.
The bigger picture
The important point is that oil is not simply an energy-market story.
A sustained move in crude can influence the entire financial system.
Higher oil prices can put pressure on inflation. Inflation can influence expectations for interest rates. Those expectations can affect Treasury yields and the US dollar. Changes in yields and the dollar can then influence gold, equities and other asset classes.
The direction is not always the same.
Gold can fall even when geopolitical tensions are rising.
The dollar can strengthen while investors are concerned about global uncertainty.
Stocks can remain resilient even as bond yields climb.
That is because markets are constantly weighing different forces against each other.
Can strong earnings and AI optimism continue to support equity markets if the cost of money keeps rising?
Oil may be the starting point, but the more interesting story is what happens afterwards.
If crude prices remain elevated, the market will be watching inflation, the Federal Reserve, Treasury yields, the dollar, gold and equities for signs of how the shock is spreading.
Because when oil rises, the story does not end with oil. It can change the conversation across almost every major financial market.
Oil is one of those markets that can have a much bigger influence on financial markets than its price chart might suggest.
When crude moves sharply higher, the impact can quickly spread into fuel prices, inflation expectations, interest rates, currencies, bonds, gold and equities. The further the move continues, the more likely it becomes that traders in other markets start paying attention.
That is what makes the recent move in oil particularly interesting.
Brent crude moved back above $100 a barrel in late September as concerns around Middle East tensions and the Strait of Hormuz increased. Prices have since pulled back from those highs as some Gulf exports recovered, but the underlying risks have not disappeared.
So rather than asking simply where oil goes next, it is worth looking at what a sustained rise in oil prices could mean for the rest of the market.
