The Fed, Jobs, and Oil

It's no surprise that short-term rates are up, but jobs increased at the same time oil prices did

By Joseph Lisanti

As expected, the Federal Reserve raised the fed funds rate by 25 basis points (0.25 percentage point) to 2%. Unless November economic data are much softer than anticipated, we think that next month will see another 25-basis-point increase in the rate that banks charge each other for overnight loans.

The Fed's move was presaged by the strong payroll employment report for October. The economy added 337,000 jobs during the month, in part rebounding from the adverse effects of hurricanes in preceding months.

One interesting aspect of the surge in jobs is that it came in a month when oil prices were climbing to $55 a barrel. That seems to indicate that employers are sufficiently confident about the outlook for their businesses and about their ability to deal with higher energy costs.

Oil prices have come down since October, and some indications are that background conditions are favorable for a return to more normal pricing. Although long-range projections are notoriously unreliable, at least some forecasters are predicting that the Northeastern U.S., heavily dependent on oil for heat, will see above-average temperatures for much of the coming winter. That's good news in light of the decline in heating oil supply in recent weeks.

Also on the demand side, Chinese imports of crude oil edged a bit lower in September, and the recent increase in interest rates in the world's most populous country might slow growth just enough to keep oil demand from surging.

On the supply side, a Nigerian court has banned a general strike that could have paralyzed the world's fifth-largest oil exporter. And the hurricane season is winding down, meaning that Gulf of Mexico wells should continue to produce.

There are still wild cards in the oil patch, and disruptions are always possible. Nevertheless, we see oil trading at about $39 a barrel by the end of 2005. As a result, S&P analysts have reduced their recommendation for energy stocks to a market weighting.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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