Will The Market Pick Its Poison? Oil Or Interest Rates?

The first thing the price of oil did yesterday, when the Fed said it would do more to help the overall economy, was to move up 5% to $94. There were some data that indicated a small drop in supply, but not enough to push crude to a multi-week high.

The Energy Information Administration’s revised its target price for crude in 2030 up almost 20% yesterday and said that the price increase would hurt economic growth between 2010 and 2030.

It was not lost on most investors that when the markets were disappointed with the Fed’s first rate cut action, oil fell with the stock market. A weak economy does not need as much crude.

So, now Wall St. and policy makers face picking their own poison. It interest rates drop, the assumption is that the economy gets better. A more robust economy drives demand for oil and other commodities. Crude rises. That eventually causes the economy to falter again.

On the other hand, interest rates can be kept relatively high by modest Fed cuts and the demand for oil may fall off. But, borrowing will be damaged and that will undercut economic growth

Experts may argue that it is not as simple as all that. They would say that there are other factors, like consumer confidence and capital spending, like productivity and the value of the dollar. It is hard to debate that there is not some truth in that.

But, it is emerging that the two biggest factors pushing around the economy now are interest rates and energy prices. When oil was at $40 a barrel, a 10% increase in prices may not have meant much. At $94 it does. When the credit markets were not in crisis, a quarter point move up or down by the Fed might not have sent investors for the Prozac bottle.

Oil and interest rates. They cannot live together well. One will kill the other, but either can kill the economy.

Douglas A. McIntyre