The Fed and Commodities

By: ispeculatornew
Date posted: 04.27.2008 (5:21 pm) | Write a Comment  (0 Comments)

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The market is expecting the Fed to cut its key interest rate by a quarter-percentage point next week and then signal that it is finished cutting rates for the time being. However, I think the best action would be to leave the interest rate unchanged. This would help deter some of the rampant speculation that has been driving commodities to record levels.

The prices of commodities, especially oil, have veered away from supply and demand fundamentals for quite some time. The speculators in oil have seized upon the theory that oil should continue to go up as a hedge against the falling dollar, regardless of what the current supply and demand situation is. If the Fed were to take the unexpected move of leaving interest rates the same I bet oil would quickly fall to one hundred dollars, maybe lower. Other commodities that have reached bubble like levels would also pull back.

Leaving interest rates the same would be much more beneficial to the economy than another quarter point cut. The Fed has already caved into Wall Street demands and dramatically cut interest rates this year with a blind eye to the resulting surge in commodity prices. Another quarter point cut won’t do much.

However, I believe leaving interest rates the same with the threat of actually raising rates would send a strong message that the Fed is willing to strengthen the dollar to reign in commodity prices. This would change the sentiment of the speculators in oil and prices would pull back sharply. This would then provide much needed relief to the average American who is dealing with record high gas prices.

In my opinion leaving rates unchanged is the smartest and boldest option. However, I don’t expect the slow and foolish Fed to take it.

Disclaimer: I have no position in oil futures.

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