Fed's Next Problem: The Iran Nuke Deal And Oil

Fed's Next Problem: The Iran Nuke Deal And Oil

Now that we've heard the Fed not-say a certain word and not-raise a certain number, let's look past the buzz at the big picture and some overlooked little details.  



Fed's Next Problem: The Iran Nuke Deal And Oil
Fed's Next Problem: The Iran Nuke Deal And Oil

The S&P 500 rallied about 30 points in the 30 minutes following the Fed's announcement. The dropping of the word patient "doesn’t mean we are going to be impatient,” said Chair Janet Yellen in her press conference.

With previous statements that "patient" meant no rate increase for two meetings, the change opens the possibility of a June increase, but most analysts say September is the earliest likely date. That's the minimum takeaway for stock investors.

CALLING IN THE TERA-LOAN

The bigger picture is the movement of roughly $3 trillion into the economy over the last seven years, as a result of quantitative easing and zero borrowing costs. Now the Fed's great task, which will take the better part of a decade, is pulling a good chunk of that money back out and exchanging it for value created by economic productivity. That's the Fed's new job: calling in their mega-loan. Sorry, make that tera-loan.

The challenge is to do it in a way that strengthens and doesn't hurt the processes that create growth for not just the US economy but the global economy. The Fed has decided to move away from forward guidance on monetary policy, a long-term campaign to keep borrowing costs low, to setting policy at each meeting based on the latest economic data. For those who look closely at the same data, it may not be that hard to make educated guesses about future policy, but the new approach does create uncertainty.

UNPRECEDENTED TIMES CALL FOR AN UNPREDICTABLE FED

Tellingly, the Fed has pretty much said they're fine with having or even causing more volatility in the markets. They want to be less easy to predict. One reason may be that the Fed is really in uncharted territory, just as they were in 2008 after a self-inflicted near-depression threw everybody's plans out the window.

One way this is unprecedented: The Fed will be raising rates just as stagnant growth and deflation fears have central banks in Europe and Asia going to sub-zero rates to stimulate growth. The tapering of QE and the threat of higher rates caused a surge in the dollar, which has jumped more than 4 percent since the January Fed meeting.

That dollar surge is pressing down almost all major currencies, making it tougher for US exporters and helping lower the price of crude oil. It's that latter trend that lies at the center of the Fed's problems, though you have to connect some dots to see it. One of those dots is Tehran, but more on that in a moment.

2015-03-18 Nadex crude oil

LIQUID MONEY

Though we talk about liquidity in money, the actual liquid form of money is still oil, because it not only makes so many things possible, it is also the overhead cost for every business, like a universal tax on everything we do.

While it might seem good to lower that tax and to lower the cost of doing business—and it is in many ways—the lower price of oil also means downward pressure on inflation. Cheap oil may keep us further from the Fed's benchmark of sustained 2% inflation. The Fed has said so many times that it won't raise rates until it sees 2% that it can't change its mind now without losing credibility.

What's more, raising rates when businesses are seeing both lower revenue (because prices are stagnant) and difficulty exporting would be damaging to the economy. They simply won't do it if that's the data they see at the next few meetings.

What about the Fed's other benchmark, sustained job creation and wage growth? The Fed sees improvement and even believes unemployment could drop further than 5.5%, but they need to see it happening in a sustained way. Again, they want to see the data and then decide. But stagnant business can't hire people or raise their pay.

OIL FOR NUKES

And what does the nuclear deal with Iran have to do with this? Oil is falling for two reasons, the strong dollar and the constantly pumping supply. US Energy Secretary Ernest Moniz is part of the negotiations with Iran, alongside Secretary of State John Kerry, but it's likely that he's not just there because the DOE oversees the US nuclear arsenal. He's also discussingthe possibility of allowing Iran to sell some of its heavy sour crude on the world market again as part of lifting sanctions.

So when the Saudis are pumping oil into the already glutted market, they are also pressuring the Iranians to negotiate and abandon their nuclear weapon plans. Iran is getting less than 40% of what it got a year ago for black market oil. Iran is even storing some of its production in tankers in the Persian Gulf, an offshore fleet of holding tanks, and would love to start selling it.

Chair Yellen has so far called oil's impact on inflation a temporary phenomenon. Bond traders are betting the opposite, that if and when the US strikes a deal that will keep Iran from developing a nuclear weapon, it will also have made a deal to let Iran pump even more oil into an oversupplied and underinflated economy. How's that for uncharted territory?


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