Watching Crude Heading Into The Weekend

We’re watching crude oil prices, especially West Texas Intermediate, as we head into the middle part of August because in a secondhand way it will be the deciding factor in whether the Federal Reserve raises interest rates in September.

WTI and Brent North Sea were both down on the day and week. Today, though, Brent took the brunt of the punishment, losing almost ½ of a percent.

Many analysts – and media pundits – are focusing solely on the U.S. unemployment rate, which is on a torturous journey down to 5%. That’s the figure that some inside and outside the Fed say is “full employment.” (We heartily disagree with such a figure. A figure solidly under 4% is full employment.)

Back to crude oil, though. While low oil prices weigh on some of the stock indices – the Dow in the U.S. – it is excellent for the world economy as a whole. On the consumer level, it’s fairly easy to grasp the positive effect of gasoline at $2.50 a gallon vs. $3.75 a gallon. It means people can do something else with the extra $500 to $1000 a year. Maybe they’re not always spending it but they are saving it, paying down credit cards with the found money, or hiding it in old coffee cans in the backyard.

Generally, low oil prices means lower inflation since energy is the connective fiber in the economic world that can’t be ignored. It affects the price of a peach and a pair of socks, a fuel pump for your car or a diamond for someone’s wedding. Almost everything and everyone has to be shipped somewhere.

Estimates vary (like fuel mileage on your car) but energy can account for more than 20% of a product or service process’s cost. Something that costs $100, therefore, has $20 in energy costs wrapped into it. If the price of energy goes down 10%, that theoretically lowers the cost of the product/service by 2%.

There has to be an awful lot of other factors to kick that 2% inflation drop back into positive territory. This is one of the reasons we see anemic inflation rises month after month, year after year.

If the Fed decides to raise the interest rate in September and then again 12 weeks later (two more meetings), it will depress prices and those prices will have to be re-inflated.

Disinflation can be a very intractable problem and can cause sever recessions or depression. Even though producer prices ticked up in July slightly above estimates, we don’t feel it’s enough to alter the course of the soft general pricing.

Subscribers should also remember that a given month’s PPI may reflect price points that were in the pipeline well before that month (again, like crude, which was priced much higher in the late spring and early summer.) So, old prices have to move through the python.

We’d like the Fed to watch its step. December seems like an appropriate time for the Fed to raise rates, then perhaps 18 weeks later.

Before we head out for the weekend. Gold saw a lot of volatility today, still reacting we believe, as a safe haven, although that play has weakened considerably. As of 4PM in New York, gold is up less than a dollar.

Wishing you as always, good trading,