Guest Post: $100 Oil Could Sink The Fed’s QE2

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Submitted byJed Graham of The Capital Hill blog

$100 Oil Could Sink The Fed’s QE2

As the U.S. prepares to embark on a new round of Federal Reserve
quantitative easing, there are plenty of reasons to doubt that it is
the right course for the economy and job creation.

Here’s another: The voyage might have to be aborted — or at least
diverted — soon after QE2 leaves the dock because the Fed may be
sailing into a political hurricane.

Even before the anticipated launch of the next round of Treasury
purchases — it’s expected to be made official on Nov. 3 — the Fed’s
unmistakable signals have fueled commodity price gains as the dollar
has sagged.

Since the Fed’s Sept. 21 policy statement, crude oil had surged
more than 9% to above $83 a barrel on Wednesday, approaching its highest
levels since October 2008. (Oil prices did retreat on Thursday.)

The risk for the Fed is that such price increases will be felt in the
economy long before any modest positive impact from lower interest
rates.

To some extent, unconventional Fed monetary policy actions may be
arcane enough to make them an unlikely target of populist politicians
and grass-roots activists.

Still, just last year, the Fed came under blistering criticism for
its close-to-the-vest dealings. Legislation to audit the Fed,
spearheaded by Tea Party favorite Ron Paul in the House and
self-styled socialist Bernie Sanders in the Senate, was largely
incorporated in the Dodd-Frank financial regulatory reform bill.

If there’s one thing that may turn Fed policy from yawn-inducer to
rallying cry, it’s oil prices rising above $100 a barrel, which would
hit Americans in their wallets on a frequent basis.

Now, triple-digit oil prices are no sure thing. If Friday’s jobs
report is far weaker than expected, it could stop the commodities
rally in its tracks. But $100 oil is clearly within the realm of
possibility, and if it occurred even as the economy continued to
struggle, there’s no telling how much hot air would fly the Fed’s way.
Perhaps enough to erode Fed Chairman Ben Bernanke’s gung-ho
consensus.

Then pressure for doing something about the jobs crisis would fall
squarely on the shoulders of Congress, exactly where it belongs.

Much has been made of hedge fund manager David Tepper’s comments on CNBC that asset values can only go up for now, driven either by an economic rebound or — if growth continues to sputter — by quantitative easing.

David Rosenberg, the influential former Merrill Lynch economist now
at Gluskin Sheff, offered a third scenario: QE2 might not work. Yet
another possibility is that the Fed has a lot less latitude to pursue
quantitative easing than is now assumed.