Friday, July 21st, 2017 MST

Oil prices impact Fed decision on interest rates

Expectations of when the Fed will hike interest rates are driving the markets.  However, no interest rate increase is likely to come from the Fed until at least June–if not farther out–according to Fed statements following the March FOMC meeting.  This means that the federal funds rate will remain at the target of zero to 1/4-percent where it has been since early 2009.

Bonds, stocks and metals prices rose on the news that any increase in the federal funds rate will not come soon.   Treasury bond prices across all maturities rose, which means that yields fell.

Before the Fed statement, the Dow Jones Industrial Average was off 152 points.  But, after FOMC statement, the Dow finished the day up 227 points for a 379 point swing.

As for the metals, gold added $36 Wednesday through Friday, and silver tacked on $1.32.

Many market analysts assert that corporate earnings are driving the stock market, but watching stocks rise or fall based on expectations of what the Fed will do suggests otherwise.  And, expectations of continued loose monetary policies fillip the metals’ prices.

Any interest rate increase may be farther out than June because the Fed named several parameters for considering when to raise rates.  For example, the Fed statement noted the “housing sector remains slow” and “export growth has weakened.”  Of course, exports have weakened.  The dollar is the strongest of the major currencies.

But, the big considerations for the FOMC are the rate of inflation and “expectations of the rate of inflation.”  The statement specifically noted ”survey-based measures of longer-term inflation expectations have remained stable.”  If expectations of the rate of inflation are that prices will fall, the Fed can justify further delaying any rate increase.

The FOMC said it would consider raising rates if it “is reasonably confident that inflation will move back to its 2 percent objective over the medium term” and “the transitory effects of energy price declines and other factors dissipate.”

Here’s the catch: the transitory (temporary) effects of lower energy costs have not been fully priced into consumer goods, which is the inflation measure the Fed watches.

A barrel of oil only nine months ago touched $115; now it’s below $50.  Lower oil prices are not yet reflected in consumer goods costs because of the time it takes to produce and deliver goods to the marketplace.  Consumer prices stand to fall even further, lowering inflation expectations, which easily could cause the FOMC to put off still further an increase in interest rates.

We are truly living in a loose monetary policies time.  Inflation, despite being low presently and likely to stay low in the near term, eventually will rear its ugly head, probably sooner than later as inflation has a history of catching the experts by surprise.

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