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As Fed Meets, Oil and Euro Face a Test

THE WALL STREET JOURNAL: As Fed Meets, Oil and Euro Face a Test

April 28, 2008; Page C1

Two related market trends — the weakening of the dollar against the euro and soaring oil prices — could be approaching turning points.

Last week, crude flirted with $120 a barrel for the first time. The dollar fell to $1.60 against the euro for the first time. But with the Federal Reserve possibly on course to pause in its campaign of aggressive interest-rate cuts, oil and the euro could be put to the test.

Since the end of 2006, the dollar has lost nearly 20% of its value against a broad basket of currencies tracked by the Federal Reserve. The euro has been one of the main beneficiaries. Over that period, oil prices have nearly doubled. The two developments play off each other because oil is denominated in dollars. As the dollar gets weaker, it takes more dollars to purchase a barrel of crude, putting upward pressure on crude prices.

Fed policy could shift this. Fed officials meet Tuesday and Wednesday to determine the course of short-term U.S. interest rates. Policy makers are widely expected to signal after the meeting that they plan to pause in their campaign of interest-rate cuts after one more quarter-point reduction in the overnight federal-funds lending rate to 2%.

A pause would signal resolve by the Fed to fight inflation, which could take some speculative pressure out of the price of oil. It could also help to underpin the dollar. Low interest rates undermine a currency because they give investors an incentive to park their money in securities denominated in other currencies that earn higher yields.

While the Fed has been slashing rates since last fall, the European Central Bank has left rates alone, meaning yields are higher in European fixed-income instruments than in U.S. instruments, drawing money away from dollars. But the tide in European rates might be turning. Germany’s Ifo business-climate survey last week came in well below forecasts. Spain’s housing sector is reeling. Italy has been hurt by the rising euro, which is curbing its exports.

It could put pressure on the ECB to start cutting rates just as the Fed goes on hold, which would be bullish for the dollar.

A stronger dollar might help to take pressure off of oil prices. Other factors have driven oil prices up lately. Last week, supply worries abounded as a U.S. ship fired warning shots at two Iranian boats in the Persian Gulf and Nigerian production was curtailed by labor strikes and rebel attacks.

Still, some investment pros say the commodity boom has gotten old. “It’s time for the commodity trade to be unwound,” says Dennis Gartman, publisher of an investment newsletter.

Falling oil prices would take some pressure off of U.S. consumers. A more stable dollar would ease pressure on the prices of other imported goods and make it easier for the Fed to control inflation.

That’s all good news for investors, but not everyone. One loser could be the oil majors. Exxon Mobil, Royal Dutch Shell, BP and Chevron all report earnings this week.

Tight profit margins on refining operations have restrained their profit romp of late. Lower oil prices would hit the production side of their business, a potentially more serious blow.

Write to Scott Patterson at [email protected] and its also non-profit sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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