Why American Stocks Might Drop Because of Oil and the Fed

Oil prices kept going down on Tuesday, after the huge decrease in the previous session that was additionally influenced by negative expectations for supply cuts by main producing countries.

Sweet crude futures for April delivery CLJ6, Light, went down by 98 cents, or 2.7%, and currently is $36.19 per barrel on the New York Mercantile Exchange . May Brent crude LCOK6 decreased by $1.11 in London to $38.43 per barrel.

Nymex crude dropped by more than 3% and Brent reduced by 2% in the latest session. Investors quickly sold their oil contracts after the news that the oil minister of Iran announced that the country wouldn’t take part in a production freeze, which is threatening supply cuts by main producing countries.

“So in case you stop producing oil now, it means you are giving your market share to Iran,” stated Virendra Chauhan, oil analyst. “The actuality is that we don’t expect a production freeze before December.” He also said that this market has a natural cap of about current levels, given the quick access to new supplies coming at higher prices.

Main oil producers have shown their intention to limit output. A production report from OPEC released last Monday represented production levels reduced by less than 200,000 barrels last month. This was mostly caused by pipeline disruptions in Nigeria and Iraq, some of which are already fixed.

Producers like Russia, Kuwait and Venezuela can’t accept the timing. They can’t agree whether Iran would be limited by a production cap. And they haven’t been able to compromise on where to have a meeting for discussion. Also, there is a much bigger problem: any limit they agree will probably do little to stop decrease of the price of crude.

Figures from the International Energy Agency represent production that the 15 countries debating a cap would reduce even without freezing production. The total output of the group will go down to 200,000 barrels per day this year because of investment cuts and huge demand, according to figures of the agency.

Nations have been debating on a production limit to address a global crude glut as oil production exceeds demand by about 2 million barrels a day. But the supply freeze that producers currently are discussing won’t have the needed influence on a global oil market, according to the IEA. Last Monday, OPEC announced that its production has reduced by about 175,000 barrels in February compared with January, partly due to lower production in Nigeria and the UAE.

Nations discussing a supply freeze include key members like Saudi Arabia and Venezuela, as well as non-members like Russia and Oman. Ministers from different countries have made conflicting statements on the nature of this supply limit. Later Ecuador deferred a meeting with other South American nations that it had been planning to have this Friday.

Some of the big players in this market in 2016 have been investors who are expecting to see the market recover. Hedge funds that have low-performing high-yield debt issued by energy companies like Continental Resources Inc. and also Chesapeake Energy Corp have been decreasing the market as a way to hedge against reductions in the bonds. The controversial result is that these investors are currently betting against themselves.

Some of the companies that have shorted oil to secure their position in debt with high yields. They are doing this because the prior mechanism for hedging oil company debt, using credit default Swaps , is less active, and the bonds have been not easy to sell without having significant losses.

Instead of this, investors are hedging their debt positions by decreasing oil prices.

It’s not obvious how big the bond investors’ short positions are, or how much they have hopes for the oil market. They still bring some pressure on oil prices and it comes from an unexpected source.

Also, this week investors will know new data on oil inventories of the U.S. Due Wednesday, the government data are expected to show that stockpiles in the key U.S. oil hub in Oklahoma are at their peak.

Investors were worried before a meeting by Federal Reserve officials. Even though no changes to monetary policy are planned, investors will review the bank’s policy statement, economic forecasts and Janet Yellen’s conference. “Market and the Fed are different regarding what they expect about interest rates,” stated Johan Javeus from the SEB. When rates were increased last December, officials predicted four more rate increases in 2016. But markets are talking about 50% possibility of a rate increase in June, and about 75% possibility by December.

“The more the Federal Reserve adapts to the market, the more upturn the statement will be received,” Mr. Javeus added.

After reducing interest rates to the negative level at the beginning of the year, “the Federal Reserve is already weakening the importance of negative interest rates as its tool” suggested a strategist at HSBC.

As for currencies, the U.S. dollar reduced by 0.6% against the yen to ¥113.105 and the euro dropped with 0.2% against the greenback to $1.1084.