Federal Reserve & Interest Rates

The stock market is rallying on the heels of falling oil prices, which are at their lowest levels since the beginning of May.  Despite the conflict that erupted between Russia and Georgia that threatens oil pipelines, oil continues it’s free fall, retreating nearly $35 from it’s July high.

“It’s become clear that demand is cratering, which is making it hard to rally,” said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts. “It’s hard to imagine that the market will shrug off the potential loss of 1 million barrels a day of pretty good quality crude but that appears to be the case.”

Oil producers have long stated that the natural price of oil should be around the $80 a barrel mark.  Heavy speculation and a falling dollar pushed oil above $100 at the start of the year and close to $150 by mid July.

Demand is falling across the globe so unless there are significant disruptions to supply, the price of oil could continue to fall.  There is no question that oil is the leader of the commodities market and it’s slide is having a spillover effect on the rest of the market.

Traders are leaving the commodities market in droves and pumping some of that money back into the stock market, fueling a rally that some experts feel could last a few weeks.  The bubble is bursting for commodities in general and it looks like the Fed was correct when it predicted that inflation pressures would ease as global demand cooled.

The stock market is taking advantage with it’s largest weekly gain since April.  So far, shipping and transportation companies are benefiting the most from falling fuel prices.

Although the decline in the price of oil is getting most of the attention, commodities have been retreating across the board for the last two weeks.

“People have gotten very worried about demand for commodities because of this global meltdown,” said Michael K. Smith, president of T&K Futures & Options in Port St. Lucie, Florida. “If all these major economies are going to slow down, people think that’s really bad news.” 

When the dollar started it’s free fall last year and inflation started to rear it’s ugly head, we saw large amounts of institutional money pouring into the commodities market.  Commodities were one of the few outlets for investors that provided decent returns with the bond, stock and housing markets all in decline.

So much money went into these markets over such a short period of time, a speculative bubble couldn’t help but form.  Unfortunately with the economic troubles that began in this country slowly spreading around the globe, that bubble is starting to burst.

On one hand it seems as if some of the inflationary pressures are starting to abate, which is the good news.  On the other hand, the reasons for this is not because conditions are improving in this country but that the rest of the world is falling to our level.

For example the dollar has been gaining in exchange markets recently but instead of thinking of the dollar as growing in strength, it’s more like foreign currencies are weakening with their respective economies.  Consider that interest rates in the U.S. are comparatively lower than much of the world, which serves to drive down demand for dollars.

If commodities continue their fall, it would allow the Fed to maintain interest rates at their current level and allow more time for financial markets to recover.

The Commerce Department released consumer spending data for June this morning.  The 0.6% increase in consumer expenditures was more than offset by the 0.8% rise in consumer inflation.

While the economic stimulus checks have provided some relief, higher food and energy prices have definitely taken their toll.  Energy prices flattened out somewhat back in April but rose sharply in May and June.

Excluding food and energy, consumer core inflation was at 0.3% which matched CPI numbers for June.  The Federal Reserve is expected to keep interest rates at 2% when it meets tomorrow.

Despite the increased inflationary concerns, financial markets remain weak and the economy continues to shed jobs.  Fed officials must be breathing a sigh of relief that oil prices have retreated somewhat, falling back down to the $120 level in the last couple of weeks.

A number of analysts were predicting that oil could reach $180 by the end of the year.  Congress has been making rumblings for weeks about placing restrictions on institutional investors and speculative trading in general for commodity markets especially oil.

With two thirds of economic growth made up from consumer spending, the next few months could be sluggish.  The federal government will probably need to institute additional fiscal policy initiatives to help spur the economy.