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.

The Dow Jones has reached bear market status and the S&P 500 is a percentage point away but a number of forecasting firms are predicting a turnaround for the market in the second half of the year.

The S&P 500 will rise 18 percent by January, according to the consensus projection of 10 U.S. strategists surveyed by Bloomberg.  The forecasts are based partly on estimates that profits will jump 50 percent in the fourth quarter after falling for the past year.

These are the same people that said that the worst of the credit crunch was over back in March so I have my doubts about a market recovery anytime soon.  Investors are still wary about the economic outlook and it is still quite possible for the economy to enter a recession although it has been quite resilient up to this point considering what has happened over the past year.

The problem is that the financial sector will continue to be weak as long as the housing prices keep falling.  Firms have already raised hundreds of billions in additional capital to shore up balance sheets to cope with writedowns from the subprime collapse and accounting changes may require them to raise even more.

While there are definitely some bargains out there with historical price to earnings ratios relatively low, it is doubtful the market can sustain a rally in the current economic climate.  Our economic troubles are also slowly spreading to the rest of the world and it seems that the rest of the world’s central banks are more committed to fighting inflation than the Fed is which will have a negative impact on their economic growth rates.

While it is likely that a global recovery will begin in this country since this is where all the trouble started, there haven’t been any signs that this will happen anytime soon.  The economy has been shedding jobs for the last six months and consumer spending is expected to fall once the economic stimulus payments run out.

There have been many critics to the Fed’s recent monetary policy decisions.  Some have cited that their actions in attempting to avoid a recession will only prolong the current stagnant economic growth pattern while increasing inflationary pressures which could have an even more detrimental effect in the long term.

At this point it might not be the worst thing in the world if the Fed decided to raise interest rates.  Right now a lot of investor money is being funneled into commodities markets but if the Fed bursts that bubble, you could see some of that money pouring back into the stock market and into the above mentioned bargains.