Monday, October 29, 2007

Interest Rate Cut Will Mean Higher Oil Prices

How a Fed rate cut raises oil prices.Everyone only sees the bright side of an interest rate cut but a rate cut will most likely mean even higher oil prices.
If the Fed cuts rates, it will probably push oil prices higher," said Adam Sieminski, chief energy economist at Deutsche Bank.

There are a couple of reasons lower interest rates usually cause higher oil prices. The first is lower interest rates are designed to spur economic growth by making money for investment cheaper to borrow. Stronger economic growth usually entails using more energy, so traders bid up oil prices on the expectation of higher demand.

Second, lower interest rates usually cause the dollar to fall, as they make dollar-denominated investments like Treasurys less attractive for foreign investors.

Oil, like many other commodities, is priced in dollars worldwide. If the dollar falls, oil producing nations, like those in OPEC, need a higher price per barrel to maintain a the same level of revenue. While oil producing countries don't set the price of oil in the market, they do have control over production and are less likely to increase it when faced with the declining dollar. Also, foreign consumers have less incentive to reduce demand if oil is, relatively, getting cheaper for them.
Those who keep telling you that a falling dollar is good for our economy are only presenting half of the story. It is theoretically good for our trade imbalance and causes more visitors to come to our shores. Our trade imbalance, although better has not seen the narrowing you would expect from the historically low dollar and a report was recently issued that said tourism was actually down. Still think the falling dollar is good news?

Remember that a falling dollar will eventually cause interest rates to spike or we will not be able to finance our ever growing debt. The Federal Reserve is putting a band aid on a gun shot wound and eventually the blood will come rushing out.

No comments: