Another Fed Cut And Another OPEC Cut: 1+1=0

October 26, 2008 by Douglas A. McIntyre

Tx00338coilwellgusherodessatexasposLas Vegas odds are currently 10-to-1 in favor that the Federal Reserve will cut rates at its upcoming meeting. This was not going to happen. The Fed is never to act just before a presidential election. It has the chance of putting its finger on the scales for one candidate or the other.

But, a deepening recession will trump precedent, and the agency will almost certainly cut rates to 1%, the equivalent of giving money away. It will be one more brick in the dam that the government is building to try to keep the sea of a deleveraging financial and housing system from swamping the economy for what many experts believe could be the better part of two years.

In general, a rate cut would have to be viewed as a benefit in getting the financial world back on track.

It is easy to forget that just this last summer the major villain in the battle to keep GDP moving was the price of oil which hit $147. Since then, the income for members of the OPEC cartel has been beaten to a pulp by falling oil prices. The consuming nations further mocked OPEC when it lowered production by 1.5 million barrels a day and papers around the world reported that the price of crude still dropped to a 17-year low.

The Fed may not be done, but neither is OPEC. Several of its members are already calling for another production cut to be announced at their meeting in December. It is not out of the question that the gathering could be moved up. Financing the national treasuries, and, in some cases deficits, of the oil- producing nations may require that oil be much closer to $90. To get the price to move in that direction would certainly require cutting another two million or more barrels of supply per day.

It is a popular perception that OPEC has been castrated by falling demand due to a shrinking global economy. That ignores the supply side of the issue. Although no one knows where the tipping point is, cutting output will eventually raise prices sharply. It would appear that OPEC is prepared to test that point.

While the Fed takes down rates almost monthly and central banks pour money into the system at will, it is worth remembering that OPEC still has the ability to damage the dynamics of bettering the credit crisis by simply getting crude back above $100. And, it can.

Douglas A. McIntyre