Fed Ups Rates & Is Now Data Dependent

A: The fed raised the fed funds rate by 1/4 point yesterday to 5.0%, the 16th consecutive 1/4 point interest rate hike which started 22 months ago. If you read UrbanDigs interest rate commentary both the rate hike & the issued statement should not be a surprise. The fed has decided to become data dependent and did NOT take a hard stance towards raising or pausing at the June meeting.

Use this philosophy for determining whether or not the fed will raise at the next meeting:

IF OIL REMAINS ABOVE $68/BARREL OR SO EXPECT THE FED TO RAISE THE FED FUNDS RATE AGAIN 1/4 POINT IN JUNE

I know its hard to sum it up that easily, but then again the price of oil is linked to so many factors right now that as long as prices remain high, inflation fears will persist and the fed will be forced to keep raising.

Excerpts From Fed Statement: Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures. "Some further policy firming may yet be needed to address inflation risks but ... the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information," the Fed said in its statement.

What the fed is doing is leaving the door open to both raising or pausing at its next meeting. It appears that Bernanke truly doesn't want to overshoot on interest rate hikes which might push the US Economy into a recession down the road; something Alan Greenspan became notorious for doing as he viewed a recession as a welcomed side effect to stopping inflation! By being more DATA-DEPENDENT, Bernanke and Co. will be able to monitor the effect of all previous rate hikes to date to see what effect they are having on the current inflationary pressures.

The problem is that right now oil is being burdened by geopolitical tensions mostly, as the surprise growth in inventory gave us a false sense of hope a few days ago. Right now the price of oil is being affected by:

1. Tensions In Iran: The letter that the Iranian President sent to President Bush did not include what the US was hoping for in terms of solving this crisis diplomatically. Instead, the Iranian leader discussed the poor state of the current world and the growing anonymocity towards America. He also included talk of democracy failing worldwide and why Israel shouldn't exist. Not exactly the best way to help with oil prices. The growing tensions in Iran are keeping oil supply fears in the minds of energy traders everywhere.

According to CNN Money:

Iran's top nuclear negotiator called the surprise letter a new "diplomatic opening" between the two countries, but Rice said it failed to resolve the dispute over the Iranian nuclear program -- the focus of intense U.N. Security Council debate this week.

2. More Violence in Nigeria: Well this is very unnerving as I seriously thought Nigeria was making headway into getting that 500,000 barrels/day back online. But, with a new wave of violence launched by militants do not expect anything to come back online anytime soon.

According to CNN Money:

The three foreigners kidnapped in Nigeria on Thursday are employees of Italian oil contractor Saipem (SPMI.MI), and at least one of them is an Italian national, industry sources said. Attacks by the Movement for the Emancipation of the Niger Delta (MEND) have forced multinationals to cut Nigerian oil exports by a quarter, and the group had threatened this week to carry out more attacks on oil industry targets and individuals.

Both the Iranian letter & non-violence in Nigeria, combined with the surprise inventory report led me to believe that a correction in oil prices was looming. I now retract that thought and obviously the oil markets are telling us the same thing as the price of oil climbs back to near $75/barrel.

AS LONG AS ENERGY PRICES REMAIN HIGH THERE IS NO WAY THE FED CAN PAUSE IN RAISING INTEREST RATES. THE BEST WE CAN DO IS HOPE THAT GEOPOLITICAL TENSIONS EASE AND THE PRICE OF OIL CORRECTS IN TIME FOR JUNE'S MEETING SO THAT BERNANKE HAS REASON TO PAUSE AND SEE IF MARKET FORCES KICK IN TO CORRECT THESE INFLATION FEARS.