S3-3: What is OPEC, the Labor Market & A Deep Dive on the Importance of Understanding Our Economy
It was another eventful week for the markets and global economy last week. OPEC+ made waves economically and politically with its announcement to cut oil production, major employment releases sent mixed messages on the labor market, and more on the Twitter / Musk buyout as the saga continues. To learn more on all of these, including what is OPEC, along with a deep dive with our Q4 FFM Book Club author Howard Yaruss on the importance of understanding our economy, read on or listen to the full episode of Finance Explained below.
What’s Moving Markets?
Early last week, the stock market rallied in the aftermath of the UK market turmoil of the week prior. However, much of those gains were erased in the second half of the week following OPEC+ announcement of cuts to oil production to boost waning energy prices and strong September employment numbers, both of which dashed investor hopes that the Fed might start to ease rate hikes soon.
For the week ending 10/7, the S&P 500 was up +1.5%, but still remains solidly in bear market territory, down 23.6% year to date. The more interest rate sensitive sector of the market are down even more, with Real Estate down 31.7% year to date and the tech-heavy NASDAQ down 31.9%.
Energy stocks rallied last week following OPEC’s announcement, up 13.6% for the week, and now up over 50% year-to-date. Energy is the only industry sector of the S&P 500 in positive territory this year.
Interest rates, after weakening the week prior in the wake of weakening of the British Pound, rallied again last week, with 10-year rates continuing to march closer and closer to 4%, ending the week at 3.89%. As a reminder, the Federal Reserve, the US Central Bank, is aggressively raising interest rates to combat widespread inflation.
Last week’s announcements by OPEC, as well as the continued strength of the labor market, gives the Fed all the cover it needs to continue to raise interest rates, as inflation continues to persist. The Fed raises interest rates to make it more expensive to borrow and to cool demand, in the hopes of easing one source of inflationary pressure. To date, the Fed has raised the Federal Funds rate, the overnight lending rate between banks, 5 times already. Their next scheduled meeting is November 1-2, where they are expected to raise the Federal Funds rate another 75bps, to 3.75-4.00%. This would be the sixth consecutive rate increase this year, the fourth consecutive 75bps increase, and the fastest pace of interest rate increases by the Fed since the 1980s.
In other market-related news last week, Elon Musk made an abrubt aboutface on his buyout of Twitter. Back in April, Musk launched a tender offer for the company at $54.20 per share, which the Twitter board ultimately agreed to. Just a few weeks after the merger agreement was released, Musk tweeted the deal was on hold over a key diligence concern – the number of real users on the platform. Musk claimed Twitter was not providing adequate information to allow his team to accurately assess the spam and fake accounts, and that his calculations implied there were far more fake users than Twitter publicly disclosed.
In July, Musk officially issued a letter filed with the SEC trying to walk away from the deal, and in response, Twitter filed a lawsuit to force him to close the deal or pay the $1 billion breakup fee. That trial was scheduled to begin this month. With the trial looming, Musk proposed closing the deal on the original $54.20 terms, and a judge agreed to delay the trial to the end of the month to give the teams a chance to work it out.
However, a major hurdle to closing remains: Musk’s funding. Back in the Spring, Musk had put together a team of both equity investors and bank debt financing to fund the $44 billion buyout. Markets have moved a lot since then, with interest rates signficantly higher, and equity prices lower. If he can’t hold the funding together, he can’t close the deal. The trial is set to resume October 28th, so he has until then to close or face trial.
What is OPEC?
A major market and economic force in the news last week was OPEC. What is OPEC? The Organization of the Petreoleum Exporting Countries, aka OPEC, is a cartel of many of the largest oil-producing countries in the world. OPEC currently has 13 members, including its 5 founding members: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.
The cartel dates back to 1960, and you may recall was a key factor in the stagflationary period of the 1970s, when in 1973, they decided to quadruple the price of oil. In 2016, 10 additional countries because the “Plus” in OPEC+. They are non-OPEC members, but attend OPEC meetings and cooperate with the cartel; Russia is part of OPEC+.
So how do these countries have so much sway over energy prices? Because they control a signficant part of the global oil supply. While the United States still produces the most oil of any scountry, we use much of it ourselves. OPEC+ countries are major producers and exporters of oil to other countries around the world. Collectively, OPEC+ controls over 50% of global oil production, and more than 90% of current proven oil reserves.
Last week, OPEC+ agreed to drop daily oil production by 2 million barrels per day. Globally, about 90 million barrels of oil are produced daily, so the cuts represent more than 2% of global supply. When you reduce supply, that increases prices, and oil prices have already increased in response to the announcement. As of Friday, Crude Oil futures closed over $92/barrel, up over 7% from just before the OPEC+ announcement. Gas prices closely track oil prices, so be prepared to face higher prices a the pump going forward as well.
This is highly concerning for several reasons. One, energy prices remain a major source of inflationary pressure, and much of the slowing of inflation in recent months was due to energy prices abating. Higher oil prices increases the likelihood of persistent inflation, and further Fed rate hikes. Two, higher energy prices helps Russia continue to fund their war against Ukraine. Russia is the second largest individual country producing oil, behind only the US, and the second largest exporter of oil in the world, behind only Saudi Arabia.
Now, OPEC exists because its member economies are highly dependent on oil. By working together to control oil production, and thus oil prices, they hope to have more oil price stability which has dramatic impact on their economies. They are likely making the move to cut production because of the looming global recession. Recessions always result in a decline in energy demand, and tend to send energy prices downward. Their production cuts are a smart business move to prevent a rapid price decline.
It doesn’t mean those cuts don’t hurt us given the impact on global energy markets. It does however highlight the importance of US energy independence and the impact that has not only economically, both domestically and abroad, but also in foreign policy for countries around the world.
The Latest on the Labor Market
Now for the last major economic news of the week – multiple releases on the current state of the labor market. Why does the labor market matter? First, from a personal finance perspective, a strong labor market means more reliable employment, income, and rising wages – which in the face of current inflation, is critical for families to be able to continue to afford their expenses.
But the other major influence the labor market has is on the actions of the Fed. The Fed has a two-pronged mission: to promote price stability and full employment for the US economy. Right now, they are aggressively hiking interest rates to reign in inflation in their goal of price stability. They will continue to aggressively hike rates until they see inflation come down, save one exception – employment.
If they see unemployment start to rise beyond acceptable levels, they may be forced to stop and even reverse rate hikes. Historically, the Fed has indicated 4-4.5% unemployment as a level consistent with full employment, allowing for new labor market entrants and job switching. Last Friday’s Employment Situation Report showed the unemployment rate for September to be just 3.5%, returning to pre-pandemic lows, and a rate not previously seen since the 1950s.
The U-6 rate, a broader measure of unemployment including those underemployed and discouraged workers was 6.7%, the lowest ever recorded for this measure. One of the challenges of the current labor market is a long-term demographic trend – our aging population. The labor force participation rate has been on a downward decline since the Great Recession, with more and more workers going into retirement, and fewer new workers replacing them.
This has created an extremely tight labor market, with more jobs in many sectors than employees to fill them, driving up wages. Hourly wages are up +5.8% over the last year. This is great news for families facing higher inflation, but remember this can become a vicious, inflationary cycle. Higher wages for you, means higher costs for your employer – which they can only pay if they raise prices for their customers… which means higher prices for you.
Another indicator for the labor market? Last week we also got the August JOLTS Report, or Job Openings, Labor Turnover and Separations. Earlier this year, job openings hit the highest level ever reported. But in August, we actually saw job openings drop 10%, the first sign that this tight labor market might finally be softening a bit. This is what I anticipated – the tight labor market will leave the unemployment rate low for longer, but we are likely to see a rapid decline here first, given the record level of job openings posted for much of this year.
We have also seen a slew of major companies announcing hiring freezes and layoffs. So far, I don’t yet see that in the weekly jobless claim numbers – but there may be a reason for that. Unlike the rapid employment cuts during the pandemic, which mostly impacted hourly workers in the retail and leisure and hospitality sectors, many of the announcements I’m seeing so far, are higher income, white collar jobs: banks, Apple and Meta, big pharma. Those jobs often come with severance packages, and whether or not you can file for unemployment if you get a severanace package, varies by state.
Overall, the labor market still remains a bright spot in the current economy. But that also gives the Fed ample room to continue rate hikes to fight inflation. However, be aware, there are beginning to be signs the labor market is softening, with the double-digit decline in job openings last month. If you work in a more cyclical industry, I would recommend reconsidering any job moves right now as well as thinking about beefing up your emergency fund in the event you experience job loss in the next 6-12 months.
A Deep Dive on the Importance of Understanding the Economy with Howard Yaruss
For this week’s deep dive I’m joined by former financial executive and current NYU Professor, Howard Yaruss who shares my passion for spreading financial and economic literacy.
Howard Yaruss is an economist, professor, attorney, businessman, and activist who greatly enjoys explaining complex issues in a clear, interesting and easily accessible way. He has taught a variety of courses on economics and business, and currently teaches at New York University. Previously, he served as Executive Vice President and General Counsel of Radian Group, one of the largest guarantors of debt in the world. He has also served on the Boards of organizations that advocate for safer streets, help for the homeless and support the arts. Yaruss graduated from Brown University, studied at the London School of Economics and earned a law degree from the University of Pennsylvania. He lives in Manhattan and serves on his local community board.
Howard is also the author of our Q4 2022 FFM Book Club pick, Understandable Economics. Howard has an incredible way of explaining even the most complex and intangible economic concepts in a way anyone can understand. If you have ever wanted to better understand major economic topics, like the Fed, monetary policy, taxes, free trade, and more, this is the book for you.
Coming in the week ahead – we will get multiple reads on inflation for September, including the Producer Price Index and Consumer Price Index on Wednesday and Thursday. On Friday, Advanced Retail Sales will tell us how consumers spending is being impacted by all the latest data. Also, Q3 earnings season is getting underway for companies, so watch for potential earnings surprises to increase market volatility.
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[…] from Howard, be sure to check out my Deep Dive with him on Finance Explained where he shares why understanding economics is so important for all of […]