Federal regulators came out blasting at high food and fuel prices Tuesday, sparking a big drop in oil, corn and other commodity prices and lifting the flagging U.S. dollar, which has fed an inflation spiral.
Federal Reserve Chairman Ben S. Bernanke triggered the dramatic market moves - including a decisive $3.50 drop in oil prices to more than $10 below the $135-a-barrel peak - by voicing concern about high commodity prices and the falling dollar. Later, the point was driven home as commodity regulators announced rule changes aimed at curbing speculation that has been driving up food prices.
"The escalation in the relative prices of oil and other commodities ... has placed intense economic pressure on many U.S. households and businesses," said Mr. Bernanke in a morning speech, blaming the "unwelcome rise" in inflation largely on "rapid growth in the emerging markets," but also on the decline of the dollar, which has lost 16 percent of its value against the euro in the last year.
Oil, wheat, corn, gold and most other commodities are priced in dollars, and the central bank is "carefully monitoring" the link between the dollar and high commodity prices because it is threatening to worsen an inflationary spiral in the U.S. and endanger the economy as it erodes consumer spending and confidence, he said.
"Higher commodity prices are for the most part a global phenomenon, but U.S. dependence on oil imports makes this country quite vulnerable on that score," he said, vowing that the Fed will set interest rates at levels that will not only guard against inflation but "ensure that the dollar remains a strong and stable currency."
Mr. Bernanke's unusually direct remarks on the dollar set off a chain reaction in financial markets, with the currency surging against the euro and other currencies and commodity prices plummeting on fears that the Fed has set its sights on fast-rising prices and will no longer promote the easy lending conditions that have fed market speculation.
Premium crude-oil prices fell nearly 3 percent in New York trading, while wheat, corn, gold and other commodities also posted declines. Stocks gyrated, with the Dow Jones Industrial Average closing down 100.97 points, or 0.81 percent, to 12,402.85, after being down more than 160 points earlier, while bond yields declined in anticipation of the Fed's more aggressive campaign against inflation.
Broader market indexes were also lower. The Standard & Poor's 500 Index dropped 8.02, or 0.58 percent, to 1,377.65, while the Nasdaq Composite Index fell 11.05, or 0.44 percent, to 2,480.48.
"The dollar's weakness is becoming bad for the economy, and the Fed is acknowledging that," said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets.
Just as the markets were absorbing the Fed's move, the Commodity Futures Trading Commission put further pressure on commodities prices by announcing that it is withdrawing a proposal that would have allowed more speculation in commodities and increasing the disclosure requirements for commodity index traders and swap dealers.
The commission's rules take aim at Wall Street hedge funds, investment banks and other speculators that have been piling into the futures markets to make quick profits on the spiraling prices of oil, corn, wheat and other commodities.
Acting Chairman Walt Lukken suggested that some of the commodities markets were not prepared to absorb the huge influx of funds from investors using commodities as a hedge for inflation and the falling dollar.
Large and small investors alike have been putting hundreds of billions of dollars into index funds that distribute their money in commodities across the board. Mr. Lukken said such index funds have come to dominate some small commodities markets, holding as much as 40 percent of the cattle futures market, for example, and as little as 15 percent of other markets.
"We want to make sure the proper regulatory controls are in place," he said. "We want to encourage access to markets, but we want to be sure too much money isn't distorting markets artificially."
Analysts said the regulatory measures could have a far-reaching effect.
"The investigation into the commodity index-fund investments is going to reduce buying interest," said Don Roose, president of U.S. Commodities Inc. "Commodities have been dominated by increased index-fund buying that might be at risk."
Lawrence Kudlow of Kudlow & Co. said Mr. Bernanke's speech marked a "major policy shift" on the troubling decline of the dollar, which many oil exporters as well as commodities traders have used as an excuse to drive up prices.
"The Fed chief has finally figured out that the weak dollar is driving up inflation" and is "putting a floor under the dollar," he said.
Because the Treasury rather than the Fed is the primary defender of the dollar, Mr. Kudlow said, he expects Mr. Bernanke got "a sign-off" from Treasury Secretary Henry M. Paulson Jr. before making the speech. Mr. Paulson spoke in defense of the dollar at a weekend meeting with Persian Gulf oil states.
Peter Schiff, president of Euro Pacific Capital Inc., scoffed at the idea of the Fed raising interest rates to defend the dollar at a time when the economy is weak and in danger of recession. He said the Fed's bark is worse than its bite.
"The market now seems convinced that the cavalry is on the way, and the dollar will turn around," but "Ben Bernanke has no stomach for such tough love," he said.