Freedom Broker warned of a risk of a market correction due to oil and yields

The combination of high oil prices and U.S. 10-year Treasury yields around 5% creates a risk of a correction in the U.S. market, Freedom Broker analysts note. Expensive energy strengthens inflationary pressure, while rising rates in the debt market increase the cost of financing and reduce the attractiveness of equities. At the same time, analysts still assess the overall balance of factors as neutral, warning that elevated volatility will persist.

Oil has intensified inflation risks

In trading on 16 September, the price of WTI oil reached $105,82 per barrel, gaining 4,53% over the day. Brent finished trading around $108,75. Prices were supported by concerns about supply cuts from the Middle East and from Libya.

Oil shipments from the Saudi port of Yanbu on the Red Sea were suspended after damage to the East–West pipeline. Saudi Arabia also canceled part of the supplies to European buyers scheduled for the second half of September. The Kingdom began offering Asian refiners additional cargoes loaded via Oman to partially offset the disruptions.

The East–West pipeline has taken on special importance as a route that allows crude to be transported to the Red Sea bypassing the Strait of Hormuz. Before the shutdown, about 4–5 million barrels per day flowed through it, which corresponds to roughly 4–5% of global supply.

Expensive oil complicates the Fed’s task

Rising oil prices increase fuel, transportation, and production costs, which can gradually be reflected in the end prices of goods and services. According to Freedom Broker, persistently expensive oil could limit the Federal Reserve’s ability to ease monetary policy. The regulator has to take into account the risk that an energy shock will slow the return of inflation to the 2% target.

On 16 September the Fed raised the target range for the federal funds rate by 25 basis points, to 3,75–4%. The regulator stated that inflation remains elevated, and that the decision taken should contribute to a more timely return of price growth to the goal.

If oil quotes continue to rise, investors may price in a longer period of high rates. Such a scenario could put pressure on the stock market even without a material deterioration in companies’ current financial results.

Government bond yields approached 5%

Freedom Broker names the debt market as the second risk factor. The yield on 10-year U.S. Treasury bonds at the time of preparing the review was around 5%. Additional pressure on the securities came from weak demand at an auction of 20-year government bonds.

Rising yields affect equities in several ways at once. First, it increases borrowing costs for companies, homebuyers, and consumers. Second, government bonds become a more attractive alternative to risky assets. Third, high rates reduce the current valuation of companies’ future cash flows.

The S&P 500 needs to break above 7650 points

Freedom Broker maintains a neutral assessment of the balance of risks for the U.S. market, but expects elevated volatility. On the one hand, expensive oil and high bond yields create prerequisites for a correction. On the other, easing inflation concerns or lower yields could support demand for equities.

Analysts cite the level of 7650 points on the S&P 500 index as a technical reference. A confident move and hold above this mark could provide grounds for a more positive assessment of the market’s short-term outlook. Until that happens, the combination of oil and debt factors remains the main source of pressure.

Not an individual investment recommendation.