Oil hits six-month high as Fed talks up inflation

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The Federal Reserve wants higher inflation. The oil market is obliging.

Crude oil futures for December rose 95 cents to $83.90 a barrel on Tuesday, the highest closing price since May 3, as the dollar weakened again and traders focused on the expectation of a new round of “quantitative easing” by the Fed.

You’re feeling oil’s surge at the pump: Gasoline prices are up 14 cents a gallon in Southern California over the last month.

Commodity prices in general have rallied sharply since late August. The Reuters/Jefferies CRB index of 19 major commodities (charted at left) jumped 1.1% on Tuesday to 304.98, a two-year high.

The Fed on Wednesday is expected to detail its next major step to help the economy: a new round of Treasury bond purchases, with the goal of pumping more money into the financial system and keeping longer-term interest rates low.

By flooding the economy with more dollars the Fed would hope to stimulate business and consumer spending.

Fed Chairman Ben S. Bernanke has made clear he has another goal: higher inflation. In a speech last month Bernanke reiterated the Fed’s concern that inflation had fallen too low, putting the economy at risk of sliding into deflation.

The “core” U.S. Consumer Price Index, meaning prices excluding food and energy, was up just 0.8% in September from a year earlier, the smallest increase since 1961.

Obviously, the Fed doesn’t want 5% inflation, let alone 10%. But something closer to 2% in the core CPI would make Bernanke less worried about deflation.

Yet the risk is that the Fed’s easy-money policy could succeed too well in stoking inflation, at least in the commodities markets. By pumping up the supply of dollars in the global economy the Fed cheapens the buck. The dollar has tumbled 13% since mid-June as measured by the DXY index (charted at right), which tracks the buck’s value against six other major world currencies, including the euro and the yen.

A weaker dollar makes commodities cheaper for foreign buyers because most raw materials are priced in dollars. That helps stoke demand for stuff like oil, copper and cotton. What’s more, the dollar’s slide has sparked greater investor demand for hard assets as an inflation hedge.

In the short term, the question is whether both the dollar’s recent slide and commodities’ hefty gains already reflect a new Fed quantitative-easing program. If the dollar rebounds somewhat and commodities sell off in the next few days, not many Wall Street pros will be surprised.

Gold, which streaked higher from late July to mid-October, has stalled out in recent weeks. Near-term gold futures added $6.20 to $1,356.40 an ounce on Tuesday. The record high was $1,376.70 on Oct. 14.

But longer-term, some analysts think market prices for many raw materials don’t fully reflect fundamental economic demand in the fast-growing developing world or the global investor appetite for commodities in general as a portfolio holding.

On both counts, “I think the demand has been underestimated,” said William O’Neill, a veteran commodities trader at Logic Advisors in Upper Saddle River, N.J.

Investor demand, he said, isn’t just a function of a weak dollar. “There’s a general lack of desire to hold [paper] currencies” for fear of governments’ power to debase them, O’Neill said.

-- Tom Petruno