The Energy Select Sector SPDR (NYSEArca: XLE), the largest equity-based energy ETF, is trading higher over the past week and while some of that may be due to oil prices and earnings reports, there is another factor to consider.
The Federal Reserve meets next week and the central bank is widely expected to lower interest rates, which could be a boon for energy stocks.
“The Federal Reserve is widely expected to lower interest rates by at least 25 basis points, or 0.25 of a percentage point, at its next rate-setting meeting on July 30-31,” reports Avi Salzman for Barron’s. “The impact of such a decision largely depends on how interest rates affect other factors—most importantly, the value of the dollar. Theoretically, lower rates lead to a weaker dollar, and a weaker dollar ought to help oil prices because oil is denominated in dollars.”
Growth Catalysts for Energy Sector
Further adding to the momentum in the energy sector, a number of U.S. oil producers off the Gulf of Mexico had evacuated and closed down operations ahead of a tropical storm expected to land Wednesday.
Additionally, analysts warned of tensions in the Middle East relating to Iran, which could further add to oil supply uncertainty in the region. The contentious relations between the U.S. and Iran have helped lift crude prices in recent months, with Iran beginning to enrich uranium above limits set out in the 2015 nuclear accord in response to heightened U.S. economic sanctions.
“In practice, however, lower interest rates don’t always have a predictable outcome on currencies. Nor does their impact on oil prices follow an easy-to-decipher pattern,” according to Barron’s. “After a rate cut in September 1998, the last time the Federal Reserve eased during an economic expansion, oil fell 40% three months later, but was up 50% after a year.”
There is another way a rate cut could help energy stocks, particularly big names like Exxon and Chevron: helping reduce financing costs.
“And it could have another effect that would help energy investors. Big oil stocks in particular have become more attractive for their dividends rather than for their growth potential. Investors no longer want to see big production gains from the major oil companies, such as Exxon Mobil (XOM),” reports Barron’s.
For more information on the energy sector, visit our energy category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.