The Fed And The Oil Markets On Unsustainable Path As Election Looms

Oil prices have increased 50 percent since the lows exhibited earlier this year, a rise that is largely linked to the positive market reaction to the OPEC output freeze. That comes even as for all intents and purposes OPEC has nearly reached its production limits and Iran still plans in increasing output.

What started the entire correction, in my view, was the carry trade on buying the Euro ahead of more quantitative easing (QE) and the Fed playing games by talking up a recovery and threatening to raise rates. That created a double whammy on a strong U.S. dollar beginning in the summer of 2014 when oil prices peaked.

At the same time, U.S. producers did manage to ramp up output even further in the second half of 2014, at a time of rising inventories. By the first half of 2015 things began to self-correct as inventories began to fall. Oil prices started to make a recovery but reversed as OPEC flooded the market with more oil, which began in late 2014. Meanwhile the nuclear deal with Iran opened up the prospect of a new source of supply, a fact that was overhyped by the media. Related: ''Iran's Return To The Oil Markets Less Damaging Than Expected''

Demand remained strong for gasoline despite the weakening global economy, much to the media's surprise. Inventories rose in absolute terms, but in terms of days of supply, storage remained at much more modest levels, only eclipsing the upper end of the historic five-year range in 2016.

It now appears that the dollar's strength is starting to reverse, in part due to the perception that the EU central bank implemented a much more aggressive monetary policy easing than expected, leading speculators who went long on the dollar to believe that the trade is over. The EU bazooka will work and no more easing by the European Central Bank will take place. Meanwhile, even though the U.S. economy is slowing, the Fed continues its madness of rate hike threats when only a few data points support such a move.

As the clueless join the more clueless down the path of failed monetary policy, at some point all this will fail to create real growth and then even the Fed will be compelled to ease again. It is possible that the markets are already anticipating this development, marking the bottom on oil and the rest of the commodity complex as the dollar loses value. Related: Oil Prices Jump As Dollar Hits 5-Month Lows

To sum up: the front running of central bank policy continues, which also creates an FX war, while real industries both prosper and fall due to these monetary experiments. Wages stagnate, economies slow and standards of living plunge as the debt from the last fiasco piles up. Just as our political process is being exposed for what it is (a few in a smoked filled room trying to thwart the popular vote), investors need to figure out what those on Wall Street will do in their smoke filled back rooms on continuing the charade.

In all likelihood oil will peak for a time as markets have yet to discount the realization of weak economic growth and the fact that no monetary policy will fix the structural problems we face. Thus, in my view, an unsustainable market rally will lead to an unsustainable rally in oil until we actually address the underlying causes of weak growth. That may or may not occur in the fall with a new administration.

If the next administration gives the economy more of the same, the propped up asset bubble that central banks created will lead to an even bigger crisis. In either case it's most likely unavoidable in the short-term. Related: Largest U.S. Refinery Now Belongs To Saudi Arabia

As an investor, the unprecedented levels of distortion and propaganda must be filtered out to clear the way to sound long-term investing. Oil prices simply cannot be held at artificially low levels forever as fundamental forces eventually come to bear. But in this day and age price distortions can last much longer compared to what history dictates.

The Fed is boxed in and that box is getting smaller and smaller. They are now in the difficult position of choosing between more monetary easing, unleashing inflation onto the already disgruntled lower middle classes when they can ill afford it, or continuing to run out the clock until the next administration through threats of rate hikes. I suspect it will be the latter as government has always kicked the can to the next administration rather than addressing the hard problems. After all, that was what the government has done over the last eight years anyway.

As always you can catch a video discussion on this and other topics on my channel

By Leonard Brecken for Oilprice.com

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