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

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.