It is Fed Day and what better day to talk about the Federal Reserve’s impact on oil price than Fed Day itself. As we all know, the Federal Reserve has taken historic actions to try to keep our economy afloat, yet if you think there are not consequences to Fed action, then you are not paying attention. As the outcry against speculators and speculation reaches dizzying heights, a study of Fed action and their direct correlation to the increase in volume and open interest as well as price, is quite clear. As the critics of speculation decry the massive surge in oil, there is only the Fed to blame.
In a world of quantitative easing and historic global stimulus, investors have more and more confidence in the price of oil than they do in government bonds. The reason is clear and that is because there is a high risk of losing money when you buy US government bonds as compared to the possible rate of inflation. Concerning government bonds across the globe, either the risk is too high or the yield is too low. This is a fundamental reason why money has flowed into oil. Investors have more faith in oil than they do some banks or governments.
Now if you think that by trying to restrict money from reflecting this fundamental fact will somehow make oil cheaper, then you are sadly mistaken. In fact oil futures will become even more coveted by those who are allowed to get them and others will seek different ways to participate in a market that, viewed by open interest growth, has more credibility than bond markets in say Greece or Spain. If you think the fundamentals of negative interest rates or default risk will change by raising margin requirements, you are in denial of the real fundamentals of the global economy and the oil market.
Some of the moves we've seen in the oil market are based on Fed action and they are quite clear yet others are more opaque. The Federal Reserve has a desire to increase oil prices to avoid the look of deflation. The Fed and their policies have pumped up oil prices as quantitative easing is as simulative to the economy as an interest rate cut and it means that interest rates are negative for investment capital to seek investment and yield. That is what the Fed wanted. It just so happens that investors looked to invest and seek yield in oil. It sends a flood of money to the emerging markets thereby stimulating more oil demand and inflation. The oil prices are reflecting this devaluing of the dollar and confidence in the full faith and credit in the United States of America which is slipping dramatically.
We do know that some of the biggest one day moves in the oil market over the last 10 years were not caused by OPEC or Libya but by Fed action and central bank comments. We saw it when the Fed cut rates in 2007 and when Europe was raising them was a prime example.
We also saw an Iranian war premium build and then fall. This is not speculation. This is the market reacting to the real and growing risk to worldwide crude oil supply. This was the market reacting to the buying of real barrels of oil to prepare for an Iranian oil embargo and the possible threat of war. This is a valid fundamental reason for rising oil prices and serves an invaluable economic purpose. The market will move to ration supply and decrease demand to try to protect the economy and ensure that we will have enough oil should supply be cutoff. That's what markets need to do. They have to be defensive and anticipate. If they did not anticipate, order could be removed from the marketplace. It could lead to shortages and disruption of supply and wild price moves. Even more wild that anything we have experienced to date.
Oil Inventories and the Fed are key today!