Oil, Dollars, inflation and Fed rates - great expanation here!

Fed leaves the rate alone today as expected – if you are curious about how some of these things relate to one another, read below. This is clear and easily grasped. Be the expert at the dinner table tonight!

Barry Habib is an analyst for CNBC and writes for his Mortgage Market Guide website. Many of you have seen this sight in my office, we watch it closely every day in order to advise our clients about locking rates.

Enjoy!

Oil,Dollars, Inflation and Fed Rates

By Barry Habib, CNBC Analyst

We actually agree with a more hawkish view - and although the Fed will not hike, we hope they decide to do so sooner than later. There is a possibility of a hike in August but it is not likely. The Fed is in a tough spot - the economy stinks, housing is struggling, confidence is low and costs are rising. You need only look at your last receipt from the grocery store or gas station to see how quickly things have changed. And a walk through your local shopping Mall tells another story of individuals who are less able to spend. That is the Fed's problem...the smart move is clearly to hike. Inflation is rapidly eating away the value of money. And while food price increases hurt, oil is the real story. So why has oil risen so wildly? The answer...The Fed. The evidence is too clear to ignore.

Let's take a look at where we were before the first Fed cut on September 18th. The Fed Funds Rate was at 5.25%, Oil was at $73 per barrel and the Euro was $1.35. Not great, but not bad. Fearing a recession, the Fed did the right thing to stimulate the economy - they cut. But cutting rates in the US makes higher rates in Europe appear much more attractive. So the Dollar began to tank against the Euro and just got worse as the Fed continued to cut. Now it takes $1.56 to equal one Euro. That is a huge swing. And here is where it gets interesting...Oil is priced in Dollars, so as Dollars decline, Oil price per barrel must rise.

Oil has gone from $73 a barrel before the Fed cuts began in September '07 to yesterday's close of $137 a barrel. And the European Central Bank President, Jean - Claude Trichet, has been talking about a rate hike in Europe even though they are headed for a recession. Remember there is a big difference between the US Fed and the ECB - the US has a dual mandate, fight inflation and promote growth. The ECB just fights inflation. And just the talk of a hike from the ECB has sent oil even higher.


Again, oil prices are surging mainly because of the Dollar weakness and the Fed cuts. Think about it - has demand for oil suddenly skyrocketed in the past 8 or 9 months? Sure it has gone up, but oil had already doubled in price when it was at $70. And higher prices for oil hurts everything. Sure at the pump and for heating, which allows less to spend, but travel, manufacturing, shipping...the list goes on and on.


Back to this morning's news - New Home sales for May were reported at 512,000, inline with expectations. The inventory of New Homes rose to a 10.9 monthly supply. This report suggests the new home sale market is still struggling.

The more "hawkish" the Fed statement, the better it will be for Bonds. But if the Fed does not at least talk tough, Bonds will be pressured and Oil will move higher.