- The Washington Times - Wednesday, August 6, 2008

Oil prices fell below $120 a barrel for the first time in three months Tuesday, helping to spark a stock rally that sent the Dow Jones Industrial Average soaring 331 points.

After a nearly 20 percent drop in oil prices from record highs in the last month, gasoline prices are down 20 cents from records near $4.10 a gallon nationwide. The developments provide much-needed relief to consumers and a breathing spell for the Federal Reserve, which found itself in a quandary Tuesday over whether to react to surging oil-driven inflation or an economy teetering toward recession.

Oil prices have dropped more than $28 per barrel since touching a record $147.27 a month ago in New York trading, in what analysts are calling a convincing retreat brought on by falling demand in the United States and the rest of the developed world. While growth in fuel use remains robust in China and other developing nations, even there the appetite for buying cars and driving has started to wilt as prices soar.

“The crude bubble looks like it’s bursting,” and that is feeding drops in gold and other commodities as investors have less need for hedges against inflation, said Matt Zeman, a trader at LaSalle Futures Group.

Crude futures prices tumbled 1.8 percent to $119.17 per barrel on the New York Mercantile Exchange Tuesday. Prices could fall as low as $80, now that the bullish market psychology that fueled oil’s relentless climb is broken, said John Kilduff, energy analyst with MF Global.

“Markets are finally working as they are supposed to,” he said. “Higher prices inevitably act as a brake on demand.”

The easing of oil prices came as a major relief at the Fed, where officials have debated openly about whether they should raise interest rates to forestall further increases in inflation. Prices are rising at a 5 percent annual rate, mostly because of the surge in oil prices. The cost of such vigilance against inflation would almost certainly be deeper recessions in the interest-sensitive housing and auto sectors, and further retreats by consumers from the nation’s shopping malls.

The Fed’s rate-setting committee left interest rates at the low levels it engineered earlier this year, with the hope that will continue to nurse the ailing economy and financial sector back to health without setting off another round of inflation.

“The Fed has been increasingly hemmed in” and unable to move in either direction, said Brian Bethune, an economist with the Global Insight forecasting firm.

“The good news at this juncture is that world economic growth has slowed down enough to induce a large downward correction in commodity prices,” he said. “That should provide the Fed with a little more breathing room,” which it will need this fall when the stimulus from tax rebates wanes, he said.

In view of the darkening outlook for the economy, “the timing of the recent break in commodity prices … could well prove to be providential,” Mr. Bethune said.

The combination of falling oil prices and the more benign outlook for the Fed and the economy sent stocks soaring. The Dow gained 3 percent to 11,616, helped in part by a report from the Institute for Supply Management showing the nation’s service sector shrank less than feared last month.

Sung Won Sohn, an economics professor at California State University, said the Fed was “between a rock and a hard place” and its dilemma was particularly acute because of stresses in the credit markets that are taking a toll in bank failures and a credit crunch affecting consumers and businesses.

To provide additional assistance to lenders, the Fed last week extended until next year several emergency lending programs for banks and Wall Street firms that it started since the end of last year.

“The central bank views the extension as substitutes for interest-rate cuts,” Mr. Sohn said, noting that the free flow of credit is essential for the economy. “With the flow of oxygen diminishing, the economy can’t function properly.”

Some economists were disappointed that the central bank didn’t raise rates to tame the inflation threat.

“The Fed has come up against kryptonite” with inflation flaring at the same time the economy is weakening, said Richard Yamarone of Argus Research Corp.

“The superhero is powerless” to combat inflation, he said. “It’s tough to justify an increase in borrowing costs with an anemic economy.”

“Inflationary pressures are currently intensifying, not abating,” said Andrew Schiff, an analyst with Euro Pacific Capital. “The recent housing bailout bill is the most inflationary legislation ever enacted and there is already talk of yet another economic ‘stimulus’ bill. The new money creation needed to finance these schemes, together with exploding federal budget deficits, will not only reverse the recent declines in commodity prices, but send other consumer prices soaring as well.”



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