Crude + Credit = Cringe

Just when you thought that the worst was behind us, we get a day like yesterday to remind us that all is not perfect in the merry ol’ land of Oz. The wicked witch came in the form of soaring crude-oil prices, accompanied by a couple of flying monkeys – that is, renewed concerns about the length and depth of the credit issues and hawkish comments from the Fed.

Before yesterday’s opening, crude oil prices had risen 35%, above $130. Wednesday’s additional $4.19 to $133.17 seemed surreal, as traders monitored data from the Energy Information Administration that showed U.S. oil reserves fell last week, contrary to expectations for modest growth in stockpiles. The timing was pretty rotten, especially if you were one of the oil executives grilled by the Senate Judiciary Committee about windfall profits and bloated executive pay yesterday.

As if oil itself were not enough to rattle investors, there was Ms. Meredith Whitney, the Oppenheimer financial sector gur-ess, who accurately nailed the credit crisis last year. She predicted that the credit crisis will continue into 2009 and that large financial institutions will likely incur credit-related losses of another $170 billion by the end of next year.

But what really seemed to spook investors yesterday was the release of the minutes of last month’s Federal Open Market Committee meeting. If you recall, the Fed cut rates by a quarter-point to 2% in April. What we learned from the minutes is that the cut was a "close call," and that future reductions are unlikely even if the economy gets worse. “Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting,” unless there was a “significant” weakening in the outlook. The minutes also revealed that Fed officials believe that the US economy will only increase by 0.3%-1.2% this year, as measured by GDP. The April estimate is lower than the previous forecast of 1.3% - 2%.

It seems to me that the economy and the markets have been fairly resilient, after taking an amazing number of blows over the past year. Yesterday’s action was a good reminder, though – while the economy and markets are healing, we are not yet done with the process. The dual bubbles that have burst in housing and credit have yet to be fully absorbed and the “crude realities” of skyrocketing oil are the biggest unknown facing investors in the short-term. Indeed, there are likely to be more trading sessions like yesterday’s, where you find yourself cringing.