As Bloomberg just noted, Janet Yellen has ostensibly signed on notion (also proffered by other Fed bankers) that the economy is strong enough to withstand an increase in interest rates. Speculators in the market have been hinting at the likelihood this would happen as soon as December In monetary policy, raising the interest rates serves two functions: 1. it can cool overheated economies, thereby theoretically averting later fiscal crashes (compared with a market that cooled under normal conditions); and 2. it provides cushion to support the market in the case of future crises (by lowering interest rates, the Fed can, theoretically speaking, warm an over-cooled economy).
The problem with the current state of affairs is that the interest rate has been roughly zero for several years… The recovery was not as strong as thought, which led to several delays of anticipated rate increases. The problem as the Fed noted, however, is that this also left the economy in a precarious position where there was no backstop should another crisis occur. Ms. Yellen indicated today (agreeing with others in the Federal Reserve system) that the economy is now healthy enough to raise the rates at least minimally, in order to provide just such a backstop. What this means for poor oil and gas speculators, though, is that Janet Yellen just said that the oil price is about to tank… as if it wasn’t already.
The reason this statement is true is actually fairly simple. People in all countries like safe investments with higher “yields”. Yields, in turn, are directly tied to the interest rates, insofar as those rates affect treasury bonds – which is to say, directly. These bonds thus become attractive to investors of all stripes, thereby increasing the attractiveness of the underlying currency, in this case the dollar. Once a currency begins to strengthen, as is probably obvious, one can buy more with less… this is good for the consumer, but weakens the value of the individual unit of any commodity that is tied to that currency. In the case of the dollar, that means… well, pretty much everything – including petrochemicals.
So, essentially, what Janet Yellen has just signaled is that she will support an interest rate hike probably before the end of the year… meaning now. That hike will strengthen the dollar… good for people earning income, but bad for people who invest dollar denominated commodities… you know, like oil. As of this writing, the price of WTI is testing the $40 floor, and I think that the traders at Goldman have it right and we will see it test the year’s low at $38 and change.