Falling commodity prices will likely slow interest rate hikes

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Bernacke

Photo Credit: Bloomberg

In the last month, Ben Bernanke must have undergone significant stress regarding the decision for interest rate policy. Since Ben Bernanke kept rates at 2%, the US markets have favored decently, while the commodities markets have dropped considerably – which is just the kind of response the Fed board would love to see from the markets. Falling commodity prices are making interest rate hikes that much more delayed; Bernanke can continue to pump the markets with liquidity without pushing commodity prices and inflation indexes to new levels.

Fed loans still getting large bids

The Fed has continued with its policy to give plenty of liquidity to banks to fuel investment and prop up the markets, but until the latest breakdown in oil prices and commodities in general, it appeared that these programs were running inflation and not contributing to a growing economy. The Federal Reserve pumped another $75 Billion in loans to banks on July 29, which was met with plenty of offers; $90 Billion worth of bids were received from a culmination of banks seeking extra liquidity as their reserves tighten.

It is, of course, the ultimate goal of the Federal Reserve to pump money into the system as quickly and as painless as possible without pushing up commodities prices, which generally rise as the amount of credit does so as well. Now that the commodities markets have fallen, it makes it that much easier for Bernanke to stand by as billions of dollars are swapped from the Fed’s coffers for generally bad loans that banks are holding. As it exists today, banks are able to convert bad debt into 28 or 84 day loans from the Federal Reserve.

Commodities will rise again

The drop in commodity prices is most likely only temporary. The Federal Reserve must act to keep money supply expanding and thwart off the threat of inflation; quite simply, there are more dollars in circulation today than when oil was $147 per barrel, but the markets do not yet reflect that. In any case, it seems as though the price of oil will follow that of all bubbles: a huge leap forward followed by a sharp decline then slowly rising prices for a duration equal to that of the bubble.

There are still many ways to play rising inflation, though commodities might not be the way. Stock markets have lagged even with rising inflation, which should generally pump up the stock markets because inflation drives the price of everything. However, we do know definitively that the impact of inflation on the commodities market was disproportionate to the rest of the world’s markets, and as oil prices deflate, we might see that money flowing back into the world’s stock markets.

Banks are cheap, not as risky at these prices

The best way to play the amount the Federal Reserve is giving to banks is in the bank stocks themselves. As the banking industry finally gets back to a reasonable credit level, the banks will cease their rapid stock dilution and be a much favorable buy for investors. Regional banks are a far better investment than larger corporate banks, as it is easy to see how their loan holdings are performing with a little bit of due dilligence into the area each bank represents.

Lenders like Washington Mutual and Citi should be left off the list for possible investments, as their assets span the entire US and are more prone to credit losses through other methods of lending, such as credit cards or car loans.

Defense stocks always do well

Another way to play this boom is in defensive stocks or stocks that produce products, which are always in demand. Consumer goods stocks favor well in slow economic times, particularly hygiene items, such as toilet paper or toothpaste, which will always have a standard demand. Inflation pressures generally push the cost of these items higher, which in turn increases profit margins – making this industry a great one to play.

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