Oil crashes to negative prices while Fed props up markets

Crude plunges to -$37.63 as stocks defy logic

On April 20, 2020, May US crude futures settled at -37.63 dollars per barrel. This had never peine before. A negative price means it costs money to get rid of a barrel: storage was exhausted, buyers vanished, and contract holders paid to unload their positions. That same day, several indices traded as if nothing were wrong.

This creates the paradox underlying all subsequent analysis. If oil is the most direct thermometer of real demand—trucks, planes, ships, factories—a negative figure describes a stalled economy. And a stalled economy does not fit with indices at levels from a year ago.

Can oil predict a stock market crash?

The short answer is that part of the market assumes so, while another denies it with numbers in hand. The most circulated comparison overlays the last two major crises—the dot-com bubble burst in 2000 and the 2008 crash—onto the current slump, finding an identical silhouette: vertical fall due to demand collapse. The nuance matters, because in 2016 prices wobbled due to supply, driven by the OPEC war against US fracking, not because the world stopped consuming.

The counterargument takes the form of statistics. Those who wield it claim the correlation coefficient R² between crude and stocks remains at 0.006. Practically zero. With three decades of historical series available, picking the two exercises that confirm the thesis has a name: biased selection. If oil replicated the index, argues the other side, trading robots would already be copying its chart. They are not, and there the disaster narrative loses one of its pillars.

Fed buys junk debt and CLOs start failing

The other front is the Federal Reserve. It is argued that its intervention has extended to all US debt markets, including the purchase of junk bonds from companies that, on paper, should find no buyer. Some read this as a flight forward: the institution supports prices no one else pays and turns the market into a branch of itself. Others respond that it is the only thing preventing immediate collapse and that, as long as inflation doesn't appear, printing causes no problem. Unconfirmed versions circulate suggesting the Fed won't allow the S&P 500 to break below the 2,200-2,400 point zone and will buy assets directly if needed.

In parallel, a technical warning appears that until recently was considered impossible. A CLO—a vehicle that packages business loans and resells them in risk tranches—has failed its overcollateralization test for the AAA tranche, the safest of all. According to Bloomberg, analysts expect up to one in three CLOs to have to limit payments to equity holders. The next threat on the list, they point out, is mortgages.

Why an oil ETF isn't suitable for holding six months

Not everyone wanting to bet on crude can buy barrels. An oil-linked ETF replicates the future, not the underlying asset, and here contango comes into play: distant maturities trade above near ones, so maintaining the position month after month eats returns at each roll. With fixed storage costs not proportional to price, at such low prices the bite is brutal. The warning repeated by veterans is simple: if you don't understand the product, don't touch it. Over six months or a year, the divergence between the physical barrel and the fund is enormous.

The dollar printer and the ghost of deflation

The argument that the United States owes money to itself clashes with a weighty objection: there is an absolute limit to credit issuance and the world is approaching it. With the global economy shut down, no one outside the country demands dollars, so oversupply is absorbed by the domestic market. The result, they argue, would not be inflation but deflation, with demand on the floor and unemployment rising. Money coming off the printer, in that reading, has no relation to real productivity.

June expirations and second-quarter results

The calendar marks two dates: June debt expirations and second-quarter corporate results, which will still take a couple of months. While these arrive, a participant draws attention to positioning: hedge funds are at their highest level of short positions in five years on the futures market, and much of the rebound is explained by closing those shorts rather than any real improvement. In an election year, moreover, it is taken for granted that the US government will do whatever it takes to support the market, even buying stocks via ETFs. The doubt is not whether it will try, but how long it can hold out.

With the Fed buying what no one wants, crude in negative territory, and quarterly accounts just around the corner, the question is not whether the market is right, but how long it can stay right before reality knocks on the door. What if the winner is simply the one who prints?