<

Statement from Fed boosted crude oil prices

2013.03.26 - Fed Funds Target RateEnlarge Graph

  • The Federal Reserve stated that it would maintain its $85 million per month asset buying program while holding a 0-0.25% federal funds rate.
  • Low interest rates have the effect of stimulating the economy and also oil prices due to several factors, including low borrowing costs that encourage corporations’ growth, and lower opportunity cost for investors choosing between yielding instruments (such as bonds) and non-yielding instruments (such as oil).

On March 20, the Federal Reserve stated that it planned to maintain its asset-buying program at a rate of $85 million per month. An excerpt of the Fed statement reads, “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.  The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.  Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative… In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.” The federal funds rate is the rate at which banks lend to each other overnight, and therefore affects the rate at which banks lend to other parties.

The Federal Reserve’s decision to continue asset buying has the effect of maintaining downward pressure on interest rates as stated. The effect of the Fed buying mortgage and Treasury securities means there is less supply of these securities on the market, which means lower yields. This also has a ripple effect through the financial system as private investors react to lower yields on Treasury and mortgage securities by purchasing securities with higher yields, such as corporate bonds, thereby increasing demand for those securities which lowers the yields on them as well.

The asset purchase program supports oil prices from several perspectives. Lower borrowing rates for homeowners has the effect of stimulating home buying which is positive for the economy, and therefore oil prices. Additionally, lower borrowing rates for corporations means that it is cheaper for corporations to secure financing to pursue new projects and grow, which is also positive for the economy and oil prices. Also, higher real interest rates have the effect of inducing investors to shift away from non-yielding assets (such as oil) and into yielding assets. For more on this, please see “Rise in real interest rates could cause commodity price declines, bearish for energy stocks.

Crude oil prices rallied shortly after the Fed statement, and ended higher on the day at $92.96/barrel compared to the $92.16/barrel close from the prior day. The Federal Reserve has continued to maintain a low interest rate stance for a period of several years, which has provided a long-term positive catalyst for the economy and, therefore, crude oil prices. Higher crude prices benefit oil companies such as Exxon Mobil (XOM), Chevron (CVX), ConocoPhillips (COP), and Anadarko Petroleum (APC), as well as energy focused ETFs such as the Energy Select SPDR Fund (XLE).