Bernanke defends QE impact on commodities

June 7, 2011 07:00 PM

It's Not the Fed's Fault.

Those rising commodity prices! It is not the Feds fault nor is it the fault of quantitative easing. Ben Bernanke faced head on the criticism that Fed policy was a major factor in soaring commodity prices answering point by point the arguments I have brought up since the beginning of QE 1 and a meeting that I had with Fed officials a few weeks ago with other commodity traders. The Fed really wanted to get our take on what was driving commodities and what impact we thought Fed Policy was having on commodity prices. Yesterday Mr. Bernanke spoke and hit all of the points that I have brought up in my daily energy reports as well as other points that were discussed in our meeting with the Fed officials.

As long time readers of my reports know since day one I have said that Quantitative Easing was wildly bullish for commodities. I said that the Fed could change the fundamentals of commodities in an instant and put bearish traders on notice that it was a dangerous proposition to be short. This was in part because of the value of the dollar but because the printing of money was even more stimulative to the price of a commodity than an interest rate cut. I wrote that Mr. Bernanke was exporting inflation to the emerging markets. Let's look at Mr. Bernanke response in full.

To say the QE 1 and 2 had little impact on commodity prices is just not right. You see the historic rises we have seen in commodities since QE 1 and QE 2 goes beyond just simple math. I was pleased to see that Mr. Bernanke acknowledged that the moves in commodities were out of whack as traders sought safe haven against the unfolding credit crisis, a point that I made at the time, something that traders thought at the time was born of the same things that Ben Bernanke is talking about today. While he made a robust argument for QE the truth is that if you look at market reactions and market sentiment you also have to look at the rate expectations differentials with Europe. As evidence we have seen some of the biggest one day moves in oil after Jean Claude Trichet either joined Fed policy or fount it. Back in 2008 when Jean Claude said the Dollar was a US problem and inflation was his problem signaling rate increase oil went limit up or hit the upward circuit breaker. We saw oil go the opposite way when the ECB signaled that they would go on hold as opposed to raising rates a few weeks ago. Plus if you look at the charts we know we had an impact on prices if only because the market anticipated more demand which I guess is the point of QE in the first place. If central bank policy did not matter why the aggressive moves in markets when rate expectations change?

Add to that the Chinese currency manipulation which helps create imbalances and were magnified by quantitative easing. Bernanank answer to China was more QE exporting inflation to them forcing them to raise rates.
You see QE changed rules of the commodity game. In a blink of an eye the Fed with its unlimited power to print money can change the dollar value of a commodity or its long term trend in an instant. If only because being short is a more dangerous proposition? The fear that the Fed at anytime can run the printing press and change the fate of a commodity because the Fed has the ammunition to make it so does play into the price expectations of a commodity. The Feds policy of quantitative easing is more simulative to the economy than a good old fashion interest rate cut but at the same time it has the potential to be much more inflationary. And now that the FED has opened that Pandora Box the markets are now from this point forward have a more complex element to them. The QE2 sent investment money to the ETF's and other commodity funds reflecting tightening demand expectations but the fact that the Fed may print money again. The debasement of paper currencies across the globe makes commodities more desirable.

I think OPEC will raise its quota, yet do quota's really matter? Really we are not talking about any new oil at this point but a legitimizing of current overproduction. Of course when you raise the speed limit from 55 to 65 most people will drive 75 instead of 65. The debate is just to make some members feel like they matter. They don't. The Saudis are going to do what they want to do and at the end of the day that is all that matters. It is nice to have spare capacity.

The pipeline outage caused a big drop in crude supply on last night's American Petroleum Institute supply report causing crude to drop by 5.5 million barrels!

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.