Tuesday, August 08, 2006

Despite the spike in the price of oil Fed still likely to pause at 5.25% the FOMC meeting on Tuesday

[I posted this Monday evening, but Blogger delayed it for some unknown reason. I post it now simply for archival purposes.]

Despite the spike in the price of oil on Monday which was caused by intense speculative buying of crude oil futures in response to news of a supply disruption in Alaska, the Fed is still likely to pause at 5.25% at the FOMC meeting on Tuesday.

Speculators in crude oil futures frequently choose to cast any news in precisely the light that helps their momentum plays, and conveniently disregard the truth. They ignore the Strategic Petroleum Reserve, acting as if it didn't even exist. The simple fact is that the world is presently awash in crude oil inventories.

Some of the rise on Monday was probably due to short-covering by bearish speculators who simply didn't like the news and exited their short positions, at least for Monday, but they'll be back soon enough.

Oil could rise a little further, but eventually the speculators will run out of steam, reverse, and then push the price back down. Ditto with gasoline futures.

As far as the Fed, the FOMC guys are smart enough not to pay too much attention to transient spikes in prices. Their focus is on forecasting demand and supply for longer periods of time. The key thing about Monday's spike was that it was driven by news of a supply disruption, and not any actual shortage, and certainly not any upwards spike in demand. In short, there was nothing that happened that the FOMC needs to worry about.

It may still come down to whether the Fed feels that it needs to establish "hawkish" inflation-fighting credentials by going for one more hike, especially in light of persistently elevated crude oil and gasoline prices. I think not, but it is certainly possible.

In short, my position remains that the Fed will hold its Fed funds target interest rate at 5.25% at the FOMC meeting on Tuesday, but will include wording that argues for vigilance and may even caution that further action may be needed if any additional inflationary pressures emerge in the coming months.

-- Jack Krupansky


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