Another major Fed moment for oil; As expected, the Federal Reserve lowered its target the Fed funds rate by 50-basis points to 1%, and it could mean that the downward move for oil and other commodities is over. The rate cut in and of itself doesn't indicate that, but their comments may be telling us another story.
It is not just interest rates that have an impact on the price or the demand outlook for a commodity. More important is the impact on the U.S. dollar and how these commodities are valued on a global basis. And judging by some seemingly innocuous words in the Fed statement like, “slowing economic activity in many foreign economies is damping the prospects for U.S. exports” means that the Fed, which earlier this year was worried that a weak dollar was feeding into global inflation expectations, is now worried that the dollar has run up too far too fast. As a result, the U.S. dollar posted its biggest one-day fall in 23 years.
This year the dollar has been a major concern for the Federal Reserve. Earlier this year the Fed Chairman Ben S. Bernanke made history by being the first Fed Chairman in decades to actually talk about the dollar. In the past, most in the position would have let the treasury discuss the prospect for the dollar. Earlier this year, Bernanke broke protocol by saying he believed the weak dollar was feeding global commodity price inflation. That comment caused the dollar to rally and commodities to break. The next day when EU President Jean Claude Trichet laughed off those comments, oil made what was at that time the biggest daily up move in history. Six months ago, the world still seemed to think that the credit crisis was still just a U.S. problem and one the U.S. had to fix. The view was that the Fed would have to cut rates indefinitely and the U.S. economy would still lag the credit-crisis immune and booming European economy. That miscalculation by Europe helped feed more false commodity price inflation as the EU said they were going to raise rates to fight inflation as the Fed lowered rates causing commodities to soar almost out of control. Yet as we all know now, Europe and the rest of the world was not immune. As the EU and the globe rushed to fix the credit problems in their own countries, it caused a total reversal of fortunes for the dollar and of course the battered Euro.
The moral to this story, besides the fact that Trichet is a stubborn guy, is that the Fed and central bank actions have been the key to every major commodity move this year. At this major point in the credit crisis, it is potentially a sign that the Fed is worried that the “slowing economic activity in many foreign economies is damping the prospects for U.S. exports;” but the fact is that a strong dollar could make things worse.
The yen has been on fire as traders are still taking off the carry trade and has raised the prospects of intervention. China cut rates as well and Asian stock markets are soaring. We have to be on guard that global central banks will use different policies and tactics to try to keep the spreads between major foreign currencies in some sort of a band. The world’s central banks went from fearing commodity price inflation to now raising the very real prospect of commodity price deflation. This is another problem that would raise many other issues that the world does not want to deal with. That is not to say that they do not want commodities to go lower than current price levels, because they do. But they want to see an orderly decline, not a crash. And that is not to say that I am not still bearish oil, because I am, but we might expect a correction and then a more orderly slower decline.
For traders, the key on oil is $71.80 a barrel. If we close above that, we could be headed up towards $80. If we fail, we should resume the march towards $56, then $50. A level that we will see eventually, but the question is whether we see $80 first.
We're short December crude from approximated 7439 - stop 75000.
Buy December heating oil at 18500 - stop 18400.
Sell Dec RBOB at 17100 - stop 18400.
Buy Dec natural gas at 515 - stop 500.
Phil Flynn
Senior Market Analyst
Alaron Futures and Options
www.alaron.com
pflynn@alaron.com
