Today’s oil move could be signalling stagflation

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StagFlation

Today’s trading was very unique. Nevermind oil’s (NYSEARCA:USO) third consecutive day of monster gains. That is the obvious anomaly that will be pointed out by everyone. In fact, oil has had its biggest 3 day gain since August 1990 when President George H.W. Bush invaded Iraq.

What was even more interesting though is that treasuries (NYSEARCA:TLT), equities (^GSPC) and the US Dollar (NYSEARCA:UUP) all traded down together. Stocks and bonds usually trade inversely as the latter is generally considered a safety trade when stocks are tanking. And on the rare occasions when they do trade down together, the dollar usually still climbs, as that is another alternative safety net when both stocks and bonds are down in the same day.

Very rarely are all three moving down together.

This could be a one-off thing, but if it continues, it is a signal of stagflation. Stagflation is when the entire Keynesian system of lowering interest rates in order to stimulate economic growth is flipped on its head. It is a combination of high inflation with recession, and it only happened once for any sustained period during the mid 1970’s, particularly during the oil embargo of 1973.

If the dollar, bonds, and stocks are headed down together while oil and commodities are moving up (the entire commodity complex moved up together with oil today) then this means that the dollar is losing purchasing power, interest rates are rising, the stock market is falling, and the cost of living is going up. Hence stagnation plus inflation, or stagflation.

In the current environment, it is generally considered a good thing and a sign of economic growth when the price of oil rises. It implies there is a higher demand for oil and hence a growing economy. But the other factor that can cause a rise in oil prices is simply a fall in the purchasing power of the dollar, or in other words a fall in the demand to hold cash as cash.

If the rise in commodity prices is being fueled by higher demand, then that would mean economic growth. But if it is only being fueled by a falling dollar, then it means stagflation.

One day of trading like this is no big deal. But if it continues, big trouble could be ahead.

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