The gloomy atmosphere in financial markets gave way to a wave of optimism Monday because of lower oil prices and expectations that the Federal Reserve Board will move to reduce interest rates within days.
Previous mood swings from negative to positive have been frustrated by continuing war fears in the Middle East, but a handful of analysts said the one-two punch of good news was just the tonic needed to bring a turn in market sentiment.
But others said that the price of oil is still uncertain, with the Middle East so volatile and that the Fed, the nation`s central bank, still may be reluctant to drive down interest rates with inflation not conquered.
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Yet a $2 drop in the price of a barrel of oil, brought on largely by reports that falling demand and rising production could cause a glut, and hopes for lower interest rates lit up a financial world that has been mired in pessimism for weeks.
Euphoria over the interest rate outlook was credited for a big jump in prices on Wall Street, where the Dow Jones industrial average closed 51.74 points higher at 2540.35. Crude oil for December delivery fell $2.02 on the New York Mercantile Exchange, closing at $32.80 a barrel.
Oil executives, in Chicago for the annual meeting of the American Petroleum Institute, also spoke of the possibility of an oil surplus through a combination of falling consumer demand and action by Saudi Arabia and Venezuela to make up for the loss of oil from Iraq and Kuwait.
They said they would expect Iraq`s and Kuwait`s 4 million-barrel-a-day capacity to come back on line over several years, given the damage inflicted on Kuwait`s oil fields and refineries by Iraq and possible further damage from a conflict.
The interest rate outlook hinges on possible action by the central bank`s policymaking arm, the Federal Open Market Committee, which will meet in Washington Tuesday to decide the course of monetary policy.
John Silvia, an economist with Kemper Financial Services Inc. of Chicago, said odds were better than even that the central bank would push short-term interest rates down a quarter of a point, just as it did two weeks ago. The Fed acts by changing the interest rate banks charge each other for overnight loans.
Analysts said a further move by the Fed would trigger actions by banks to reduce their prime lending rates, which would help lower rates for mortgages, auto loans and borrowing for consumer purchases.
The prime rate has been at 10 percent since January. Any move to nudge it lower would be seen as a boost to economic activity because about one-third of all consumer and business loans are tied to changes in the prime.
”The Fed wants to reassure financial markets that the U.S. economy remains under control,” said Samuel Kahan, chief economist of Fuji Securities Inc. in its Chicago headquarters.
He said the Fed may not move quickly, to avoid the appearance that it is being stampeded into action by recession worries. But he said a move is likely within a week.
Professor Haskel Benishay, of the J.L. Kellogg Graduate School of Management at Northwestern University, said he believes the Fed will take ”a very small step, at best-something symbolic, rather than meaningful.”
Benishay said Fed Chairman Alan Greenspan ”is looking at consumer price inflation for this year that will finish 6 or 6 1/2 percent higher than last year. That would give him pause.”
Some analysts said they want a cut in the Fed discount rate, which it charges commercial banks. The Fed hasn`t cut that rate, at 7 percent, in more than four years.
Arguing in favor of a quick move was Friday`s report on wholesale prices for October, which, though showing a big jump in energy costs, showed the so- called core rate of inflation flat. The core rate, which excludes the volatile categories of food and energy, is widely perceived as an accurate barometer of inflation.
Some analysts said the Fed must wait to see a report on consumer prices for October, due Friday. If that were to show another leap in inflation, it would argue for a go-slow attitude on interest rates.
Another argument for holding steady is the recent weakness of the dollar against foreign currencies. The greenback is at an all-time low against the German mark and Swiss franc, and it has fallen steeply against the Japanese yen in recent weeks.
Some economists worry that the dollar could go into a free fall against overseas currencies, as U.S. investments become relatively unattractive.
Meantime, oil company executives said they expect the price of oil to hold at $25 to $35 a barrel as long as the Persian Gulf crisis continues, go up dramatically in the event of war and then fall back within a few years to $20 to $25 a barrel.
The $20- to $25-a-barrel figure represents an oil price determined solely by supply and demand, said Roger Morrow, chairman and chief executive of Amoco Corp. Morrow addressed the Association of Petroleum Writers Sunday night at the commencement of the American Petroleum Institute`s annual meeting here.
Morrow said use of military force in the Persian Gulf would have a major impact, but its extent would depend on such elements as the length of a conflict and damage to Saudi fields and refineries. The price conceivably could go well beyond $40 a barrel, he said.
Many analysts at the conference spoke of a $10 to $15 a barrel ”war premium” that could disappear quickly in the event of a peaceful resolution of the crisis. Oil executives strongly supported a peaceful settlement.
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”If Saddam Hussein pulls back and things get resolved, and I hope it will, there will be an excess of capacity,” said Mobil Corp. Chairman and Chief Executive Allen E. Murray, who is institute board chairman this year.