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Interest Rates Are They Coming Down?

By Andy Shaw | January 25, 2010

Originally Posted 18th September 2008

A few months ago when the inflationary pressures looked to be at their worst and the world seemed to think that the prices were only heading one way, I said that oil prices and commodities in general would fall sharply. I think oil was at $145 and still heading up at the time. I don’t think I said it in that article but I did in a later one, that I thought oil would end up somewhere between $90 & $110 in the short term. So when last week oil dipped below $100 in less than 3 months after me saying this, it brought a smile to my face.

But is this magic? Did I just guess right? It’s neither. The cure for high prices is high prices; the economies of the world were heading toward a recession and therefore wouldn’t be able to afford to buy the stuff (or for that matter any other commodities). I also looked into reports that oil producers were renting tankers to store oil in, as they couldn’t sell it, so it’s hardly magic and in fact quite easy to predict even in today’s turmoil.

Side note:

So why is it then that some things which should be predictable are not so easy to predict? Well, that’s when someone in power isn’t playing the game the way that they are supposed to play it. This is usually because they are learning the game or just not competent enough to understand the full ramifications of their actions.

I’ve included a few links below with graphs that look like large mountain regions in the Himalayas. The first one is the crude oil price, and the next one is the commodity futures. You’ll see that oil resembles a big mountain and commodities looks like the Eiger.

http://www.wtrg.com/daily/crudeoilprice.html

http://www.bloomberg.com/markets/commodities/cfutures.html

Well most of the indicators I see are showing us that unfortunately the market downturn for the economy is going to get worse and not better. We seem to be following a close third to Spain and Germany’s lead into recession. The US economy now looks like it is slowing once again and heading the same way too. The government and the Fed have managed to hold recession off this far and thanks to this have made the idea of recession a lot more palatable than it would have been with interest rates at 5.25%.

Now to carry on with the US here for a minute, unemployment in the states is the biggest worry. Payrolls fell by 75,000 after declining by 51,000 in July and the unemployment rate stayed at a 4 year high of 5.7 percent. (This is one of my biggest concerns for the UK too, especially as unemployment took it’s biggest jump in August for 16 years and I saw recently that some forecasts are predicting a rise from 5.5% to 6.7% in 2009, and then going above 7% in 2010! If this is correct, and I think that it is, then this is very bad news as this shows from just one indicator that we could be looking at 2011 before we see a recovery or possibly even 2012. If correct, then this means we will be in for some very uncomfortable years ahead, especially with an interest rate stuck at 5%)

As I type this the US government and the Fed are devising ways to help the people through this by various methods. And the Presidential candidates have even mentioned the possibility of lowering rates further to well below 2%. That’s 2% for those not up on current affairs. Not the 5% that we are paying, nor the 4.25% that the Euro Zone is paying.

America cut rates despite what the inflationary indicators said and this took their currency down with their rates. They went to bat and tried, and are still trying, to save their economy and country pain. All this despite the fact that what they did looked like fools’ play.

Now approx 70% of America’s GDP is made up by consumer spending, and given the inability of US consumers to borrow against their homes, and with rising unemployment, this is going to be hit hard. Consumer spending data showed retail sales dropping 0.3% in August for the second month in a row (July was down 0.5%) The government will look for ‘new ways’ to keep their people spending as otherwise their whole economy will suffer. They don’t seem to operate the blame culture as much, or in anyway the same way, as we do in the UK & Europe. They take the much more Entrepreneurial stance of, ‘This is where we are, what do we now have to do to sort it out?’

So with all these commodity prices having come down and the value of the dollar increasing, it gives the Fed more scope to lower rates and come up with new alternatives to stimulate the economy (although they won’t be admitting that for a while).

So how can the Fed be even considering lowering rates, given that only recently they were under pressure to put them up?

Well as I said in another article a few months ago, all of the price increases were raising inflation, but when these fell back they would not only lower inflation but could actually cause deflation. I think that picture, whilst it only had a slight chance of happening a few months ago, has now become clear and has a real chance and is even very likely to happen.

Now if oil drops even further than I predicted and goes down to $75-$80, which it very well could, that would really have the effect of decreasing inflation by a significant amount and it would also drag down counterpart commodities as well. Now given that Europe and Japan are in recession, and the emerging markets have reduced their demand because of the high prices, the thinking that oil in the short term could be lower still no longer seems so unreasonable, as it was when I first wrote about it at the peak. (Long-term, however, I think that oil will go much higher than it is now and much higher than it was in the summer, but that is another story.)

Side note:

I know that some of this stuff may not be very interesting to the majority but it is actually the very stuff that brings about the interest rate changes, and therefore I like to include it rather than just tell you where I think rates are going. Hopefully it gives you insight into my arguments and assumptions, so that you can learn to read the indicators as I do.

So what does this mean for us?

With this inflationary pressure curbing off, I think finally both the BoE and the ECB are likely to cut rates. This is going to make the dollar stronger still, which could push inflation upwards again or much more likely will just slow its decent. However, I think this time next year we will start to see stories about deflation given that we have seen two major bubbles burst in the last year (housing and credit). It is not out of the realm of reason and this is what should happen, as bursting bubbles are by definition deflationary events.

So unless Mervyn is set on getting us into a quick recession (which I tend to think he is) and stuff all those that don’t survive, then I think we could be about to start seeing a series of LONG OVERDUE rate cuts. I did hope that ‘reason’ would have brought these about sooner than they have done but I think the question is now, not will they but when will they and by how much?

Now if the powers that be were reasonable then I’d be able to predict this without too much trouble but for this decision I think we’ll have to wait and see and as I am trapped in Cyprus at the moment and being not so connected to the financial markets, I’m not willing to say if it will be this month or next, but I think it will start this side of Christmas (FINALLY).

However, these guys have gone against the grain before and they could do again, so we’ll have to wait and see whether they want recession badly enough or not. We live in interesting times!

Best wishes

Andy

PS I’d like you to know that I wrote this Sunday morning just before the Lehman Brothers problems showed up on the news. It demonstrates just how much is happening at the moment. I’m still in Cyprus and it is Thursday morning now.

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