It’s Not Just Oil
August’s 3.4% annual increase in the Consumer Price Index (CPI) shows that inflation remains stubbornly high.
Higher energy prices remain a key driver, up 16% year over year. In addition to higher oil prices tied to the Iran conflict, reduced global refining capacity—driven in part by the Middle East and Russia-Ukraine conflicts—has pushed fuel prices higher. According to AAA, at the time of this writing, the national average price for regular gasoline is $4.30 per gallon, up about 35% from a year ago; diesel is $6.06 per gallon, a record high and up 63%.
But energy commodities aren’t the only commodities responsible for broad-based price pressure. Consider the Bloomberg Commodity Index (BCOM), which is a widely-followed benchmark that tracks the prices of futures contracts on a diversified set of physical commodities. The BCOM is at a record high, while oil prices, while still elevated, are down from April’s highs. See Exhibit.
Exhibit: Bloomberg Commodity Index
Agriculture commodities are also elevated. Corn, cotton, soybeans, soybean meal, sugar and wheat are at or near their highs for the year. Higher fuel and input costs related to global conflict, along with extreme weather, have helped push up their prices.
Copper is also setting record prices. Demand remains strong, supported by the artificial-intelligence buildout, electrification and power-grid investment. And higher demand is met with supply constraints that include mine output challenges and potential tariffs on imported copper.
Against this backdrop, attention now turns to the Federal Reserve. The Fed’s preferred inflation measure excludes the volatile food and energy categories. Core inflation remains above the Fed’s long-stated 2% target, and August’s month-to-month change in core CPI came in higher than economists expected. As of this writing, traders see about a 90% chance that the Fed will raise rates at its September meeting. The concern is that higher energy costs could feed into core prices if companies pass higher input costs on to consumers, or if employees seek higher wages to offset rising costs, creating a wage-price spiral.
So far, financial markets have taken these developments in stride. Long-term government bond yields have increased, but corporate bond spreads—a gauge of investor confidence in financial markets—remain well behaved. Global equities also remain in a well-defined uptrend. We will continue to monitor markets for signs of stress.
BULLISH
- Consumer spending remains resilient
- Corporate profits are increasing
- Yields for fixed income and cash remain attractive
- Credit spreads remain contained
- Consumer and corporate balance sheets generally remain healthy
BEARISH
- Even when hostilities in the Middle East stop for good, it’s likely that oil prices will remain higher than their pre-war baseline for the foreseeable future.
- Housing affordability remains at decades-low
- China is experiencing a growth recession and deflation fears
- Federal debt and deficits have ballooned