While Hurricane Ike may have been a large storm in a literal sense, the spiral engulfing cornerstone financial institutions is a much larger storm, figuratively.
The chronicle of events that produced $147 per barrel oil were legion, punctuated, in July, by fears over an imminent attack on Iran by Israel, with or without help from the US. Underlying it all, however, was financial liquidity. The weakness of the US dollar was emblematic of this liquidity.
For most of the run to the record, I was able to cite the silver lining of a seemingly booming economy that was generating forward-looking energy demand that was increasingly perceived as approaching insatiability. Oil prices were rising for a good reason, at least.
Speculation, certainly, played a role. It made sense to acquire an exposure to hard assets, particularly in an environment of sustained growth from newly emerging industrialized economies in Asia, and investors augustly did so.
Since the record set in July, a lot has changed. The euro has gone from 1.60 versus the dollar to under a $1.40, at one point last night. In terms of currency trading, this is a move that eclipses that decline in energy prices. Europe and Japan are now, for all intents and purposes, in recession. China is being closely watched, as to how its economic activity will hold up in the post-Olympics period.
The events of this weekend, with the loss of Lehman Brothers and Merrill Lynch,and AIG Group teetering on the brink of a similar fate, are producing a knee-jerk reaction by investors. Treasuries are up, as is gold. Everything else, including oil, looks to be down sizably. I had argued that oil had joined the ranks of these safe-haven investments. In these most troubling of times, oil does not appear to make the cut.
I am holding to my outlook that oil does not have much farther to fall, if at all. I expect the Federal Reserve to act aggressively, possibly cutting rates, at its meeting on Tuesday, by as much as 50 basis points. This action should produce further dollar erosion and a clearer view of the path out of this thicket. I believe the Federal Reserve will choose to try to inflate our way out of this crisis.