How Will the Fed Deal with Falling Oil Prices?

10/31/2014 12:01 am EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

With the Fed meeting this week, MoneyShow's Jim Jubak thinks that falling crude oil prices will make their decisions on interest rates even more difficult.

For the week ahead, look at the Federal Reserve and oil. Now, the Fed met on October 29, its regular meeting of its open market committee to decide on rates, decide on ending the quantitative easing three and the purchases of assets. Oil really sort of makes the feds job harder because while you've got the feds saying, “Well, okay, so the economy is of this strength or not this strength and, therefore, we should raise rates here or not, we can get rid of the remaining $15 billion of asset purchases,” but then you've got oil.

You've got the fact that oil prices are seemingly headed below $80 West Texas Intermediate and this puts a huge stimulus to the economy so one of the things the fed has got to figure out is, okay, if we are indeed lowering oil prices so that all of the companies that use oil to make things, all of the companies that use oil to transport people or things, all of the people who pay for gasoline at services stations, all of those people are getting a big bonus, a rebate if you will, and that adds to US growth. Instead of spending $4.40 at the gas station, you spend $3.80, that gives you 70 cents per gallon to spend somewhere else so it's a big bonus for the US economy.

The question the Fed has is looking at this, lower oil prices are a reason not to move toward anymore stimulus. The Fed doesn't include them in its normal inflation measures so that's not part of the problem. The question is so how much extra growth do you get in the US economy because of oil, how long does that go on, and how does that affect the fed's decision on when to raise interest rates?

If you look at this and go, “Okay, so the Fed is saying the oil drop is not going to last very long or is not going to last significantly long,” then the Fed says, “Well, we're going to raise rates around the middle of 2015,” which is sort of the consensus opinion. If it thinks that the bonus from lower rates is going to go on for a while, they might actually move to raise rates earlier so it's the big wild card. Trying to figure out what the Fed thinks about oil and where oil is going really tells you a lot about where interest rates are going to go and when and that, of course, is the big question for the financial markets.

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