Oil prices have been especially volatile this year, torn between a political standoff with Iran and a slowing global economy.
But now the fate of oil prices lies with just one man: Federal Reserve Chairman Ben Bernanke. Essentially, the future direction of oil prices will be determined by his (and the Fed’s) decision to opt for more stimulus measures – a decision that he’ll be forced to make soon…
- The Labor Department said last week that just 80,000 jobs were added in June – far fewer than economists projected. And the unemployment rate stayed unchanged at 8.2%, making June the 41st consecutive month in which unemployment has been above 8%.
- Making matters worse, manufacturing in June contracted for the first time since the recovery began. In May, consumer spending fell for the first time in seven months, and consumer sentiment hit its lowest level since December.
- Weaker inflation also indicates that the Fed might need to take additional stimulus measures. Prices rose just 1.5% year-over-year in May, below the Fed’s 2% target, according to the Personal Consumption Expenditures Price Index. That’s the lowest since January 2011 and down from a peak of 2.9% in September.
Now, if the economy continues to deteriorate, the Fed will have to intervene, which could mean purchasing more U.S. Treasuries or mortgage-backed securities. And this attempt to spur the economy would weaken the U.S. dollar and, in turn, boost oil prices.
Remember, oil and other commodities are priced in dollars. So they increase in value as the greenback weakens.
Of course, with the sovereign debt crisis roiling markets in Europe and threatening the very existence of the EU, the dollar has been on a serious winning streak. The possibility of a global downturn has revitalized the currency’s reputation as a safe haven. And the possibility that the euro currency itself may cease to exist has sent investors scrambling to limit their exposure.
In fact, the Dollar Index, which tracks the greenback against a basket of six foreign currencies, is already at its highest level since July 2010.
If that trend continues, oil prices will continue their downward trajectory (barring an all-out war with Iran, of course).
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However, if Bernanke could put a floor under oil prices by further easing the monetary policy.
He’s already assured that the Federal Funds rate – which currently stands at a record low range of 0% to 0.25% – won’t change until late 2014. The central bank has also extended Operation Twist, which lowers long-term interest rates. These measures can indirectly push oil prices higher.
And it looks like the Fed might soon take further action.
During its June 19-20 meeting, the Federal Open Market Committee (FOMC) showed much stronger support for additional stimulus measures than previously indicated. While the FOMC was still reluctant to deploy more stimulus measures, more members acknowledged that risk to the overall economy, particularly employment, had grown.
International pressure is increasing, as well. Over the past few weeks, policymakers the world over have been responding to the faltering global economy.
The EU made the biggest splash with its plan to pump money directly into troubled banks.
Meanwhile, the People’s Bank of China cut its benchmark rate by 25 basis points and lowered lending rates by 31 basis points. That was the central bank’s second surprise rate cut in a month’s time. And recent reports of accelerating job losses could entice more government action.
That makes the United States the only major country that hasn’t announced a fresh raft of stimulus measures. And the international community has taken note.
In fact, IMF Managing Director Christine Lagarde has already called on the United States to pitch in to the recovery effort.
“Continued policy action is needed to boost the recovery,” she said. “We believe the U.S. authorities do not have a lot of space to act, but they should use it to support the recovery in the near term.”
Indeed, in addition to weakening the dollar, more money sloshing around the system could provide enough of a boost to the economy to whittle down some of the excess oil supply that’s accrued.
It could also reverse the downward trend in consumer sentiment. That would mean more consumers buying products from places like China, which would have to import more oil to fuel its manufacturing base.
So truly, where oil prices go from here is for Ben Bernanke and the Federal Reserve to determine.