Alaron Energy Comment

CHICAGO - Jul 21/09 - SNS -- Following is the energy futures comment from Alaron Trading Corp.

We got to get out of this place, if it's the last thing we ever do. And it will   likely be for an extended period. Big bad Ben Bernanke talks about an exit strategy from his policy of mutative easing in today's Wall Street Journal and says they have a plan when the time is right. Ben says that the plan will not happen for an extended period yet.

Why is this important to oil? Well mainly because the Fed has been the main driver of the price of oil.   In the Journal, Ben Bernanke wrote in an   editorial piece  about his accommodative policies and the  functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. The Federal Open Market Committee, which is responsible for setting U.S. monetary policy, has devoted considerable time to issues relating to an exit strategy. We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

Mr. Bernanke says that, "the exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.  But as the economy recovers, banks should find more opportunities to lend out their reserves."

That would produce faster growth in broad money (for example, M1 or M2) and easier credit conditions, which could ultimately result in inflationary pressures,  unless we adopt countervailing policy measures. When the time comes to tighten monetary policy, we must either eliminate these large reserve balances or, if they remain, neutralize any potential undesired effects on the economy.       To some extent, reserves held by banks at the Fed will contract automatically, as improving financial conditions lead to reduced use of our short-term lending facilities, and ultimately to their wind down. Indeed, short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion as of mid-July from about $1.5 trillion at the end of 2008. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Fed mature or are prepaid. However, reserves likely would remain quite high for several years unless additional policies are undertaken.

Bernanke says that, 'Even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time: paying interest on reserve balances and taking various actions that reduce the stock of reserves. We could use either of these approaches alone;

However, to ensure effectiveness, we likely would use both in combination.     Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.  Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.         Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed."

Now of course Ben's Humphrey Hawkins testimony  will be a bit less exciting. Obviously as the fed exits, whenever they do, we will see the dollar rise and oil fall. That will drive oil prices lower.

Are you Fed up with the Fed? Get even! Trade futures!! Just call me at   800-935-6487 or email me at pflynn@alaron.com to open your account. Also check me out every day  on the Fox Business Network. Press should turn in to the Dow Jones Indexes Mid-Year Commodities Outlook that I will be speaking at today at the CME Group floor!

Sell September crude  at 6660 -  stop 6760.

Sell September RBOB at 18000 - stop 18500.

Sell September Heating oil at 17450 stop 17650

Sell September natural gas at 390 - stop 430.

Phil Flynn

Alaron Research Team

800.563.9510

pflynn@alaron.com

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