Why the Fed Is Not Following Oil Lower

The collapse in Brent crude has removed much of the immediate inflation fear that gripped markets through the first quarter. The front-month contract has shed roughly 15% from its April peak, settling near $72 a barrel on Friday. That slide has been a tailwind for equities and bonds alike, with the S&P 500 recovering 4% from its April lows and the 2-year Treasury yield pulling back 25 basis points from the cycle high.

The Federal Reserve has not followed the oil market's lead. Chair Jerome Powell, in his post-FOMC press conference last week, repeated the same language he has used since January: the committee needs "greater confidence" that inflation is moving sustainably toward 2% before cutting rates. The dot plot showed three cuts penciled in for 2025, unchanged from March. The median terminal rate projection ticked up 10 basis points.

The relief rally has met a more demanding Fed. The central bank is treating the earlier inflation scare as a data point, not an anomaly. The April CPI print came in at 3.4% year-over-year, down from 3.5% in March, still well above the 2% target. Core services ex-housing, the category Powell watches most closely, ran at 4.9% annualized over the three months through April.

Traders have priced in a 60% chance of a September cut, according to CME FedWatch. That is up from 50% a month ago, still below the 75% probability that prevailed before the March CPI surprise. The market is betting that lower oil will pull headline inflation down enough to give the Fed cover. The Fed is betting that services inflation will prove stickier than the commodity-driven disinflation of 2023.

The 2-year yield, now at 4.72%, has not broken below the 4.65% level that marked the post-March low. That level matters. A clean break below it would signal that the bond market believes the Fed will cut in September regardless of services inflation. A hold above it would mean the relief rally has run its course without changing the rate outlook.

For the S&P 500, the test is whether the earnings season can sustain the move. First-quarter results have been solid, with 78% of companies beating estimates, according to FactSet. Forward guidance has been cautious, particularly on margins. The energy sector, which contributed roughly 8% of S&P 500 earnings in 2024, is now facing a 15% drop in year-over-year profits if Brent stays at current levels.

Micron Technology Inc, with an Alpha Score of 77/100, sits in the technology sector where the earnings picture is more mixed. The memory-chip maker has benefited from AI-driven demand for high-bandwidth memory. The broader semiconductor cycle is showing signs of peaking. The Philadelphia Semiconductor Index is up 12% year-to-date, the rate of gains has slowed sharply since March.

The relief rally has bought time. It has not bought a policy pivot. The next test comes on June 12, when the May CPI print lands. If core services inflation does not moderate, the 2-year yield will retest 4.90% and the S&P 500 will give back its oil-driven gains. If it does moderate, the September cut becomes the base case and the rally has room to run.

The Fed has made its position clear. The oil market has made its move. The CPI will decide which one is right.