Oil Drives the Market

Over the last week market prices have been reacting very negatively to oil prices and we will likely see more today when trading begins. One thing that is starting to be mentioned more and more in the news is the effect this will have on inflation in our country. Higher oil prices don't always cause higher inflation, however at current levels this is a major concern. Consumers should be weary at the pump with gas over $4.00 per gallon but they should also be weary at the stores they visit whether it be the mall or a grocery store. Prices are on the rise because transportation costs are increasing and producers are beginning to transfer these higher costs to consumers. With the economy as it currently is this is potentially frightening news because people are already strapped for money as is and with higher prices something has got to give. Some are calling for stagflation which is when growth in GDP and employment is slow while prices are rising. Every time stagflation comes up the next thing that comes to mind is the Fed, since we assume that the Fed can control economic conditions limiting the chances of actual stagflation. This is very true for the most part, but the past will tell us that stagflation does occur in the U.S. (1970s -Oil Shocks)

When combating this problem the Fed needs to use current and reliable data, not predictions from analysts at investment banks and oil and gas companies. Two numbers that I have heard recently are $150/barrel in July 2008 and then $250/barrel by the end of 2009. Don't forget that there are a million other estimates out there some below current market prices and some above (the consensus is probably above). I'm sure both the companies that issued these target prices were wrong in their predictions about current prices, so why are people so quick to believe them now. The quick answer is that people want to believe that prices are predictable and that we have the knowledge and information to effectively pick out precise targets. Well I'm here to say that things aren't as easy as it seems. Prices could go anywhere from here because oil markets are not trading on purely fundamentals anymore which can be seen from the $10 move it made on Friday. Traders are putting in longs and shorts that may backfire if the smallest bit of news hits the wires. Plus now OPEC and Congress are in the mix which means things must be out of line and need "correcting." Knowing that oil doesn't trade/price fundamentally makes it even harder to target a price. I just advise caution before making conclusions from oil price targets.