Did Deflation fears help rally the oil market? Oil prices popped as the dollar index dropped hitting the lowest level since last April. The market seems convinced that the Euro zones problems are behind us so it appears that the carry commodity trade is back in play but could we see more problems up ahead?. Of course while the dollar has been trending lower and the Euro higher is this a sign that we are headed for a bought of commodity price inflation or are the markets more worried about deflation.

Yesterday the markets heard some very provocative comments from Federal Reserve Bank of St. Louis President James Bullard who said that the US is closer to a Japanese-style (deflation) than at any time in recent history. Mr. Bullard said that in his opinion that the Fed should get ready to expand the quantitative easing program should the economy start to slow and send a clear signal to the markets that rates will remain near zero. This kind of talk of course is bullish for commodities.

As I have said from the first day that the Fed went to quantitative easing that the Fed just printed a floor under commodities. By creating inflation and money out of thin air the Fed changed not only the underlying value of a depreciated dollar but its entire price structure in regards to other commodities. If the Fed chooses they can create commodity price inflation and they hope some demand as they try to inspire economic activity by flooded the world with dollars. This is why oil prices remain stubbornly high despite a global glut of supply. Quantitative easing and essentially negative real interest rates has probably added a $10 to $25 a barrel premium to a barrel of oil.

With the talk or more quantitative easing being too short commodities is a more dangerous proposition. At anytime they can run the printing press and change the fate of a commodity or at least its price. Of course there are dangers to this policy. If inflationary effect on oil outweighs the economic stimulus effect of lower long term rates, the oil drag on the US economy could drive us even closer to that Japanese Style deflationary funk.

That is exactly the funk that we are trying to avoid.  If the printing of money cannot inspire banks to lend and stir economic activity and job creation then all that is left is commodity price inflation that may restrict the type of growth that is necessary to promote the type of economic activity to restore the economy back to a normal path. So what now should be apparent that at this stage of the recovery we now know that the Fed cannot do it on its own? The Fed has done what it had to do but now it now up to the lawmakers down in Washington. The next step that has to be taken is to make a plan to bring out of control spending under control and to cut corporate tax rates to restore confidence.

You see based upon the near record low yields that we are seeing in the market place we still have fear gripping the market place. Washington has created no real long term plan to fix the deficit and right now is only adding to it. It has no plan to kick start the private sector and in fact has hurt the private sector by creating more uncertainty with financial regulation and health care bills. Make sure you are getting my daily trade levels and make sure that you are watching the Fox Business Network. Just call me at 800-935-6487 or email me at pflynn@pfgbest.com

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