As the world watched for a general decline in inflation, a potential 2023 economic surprise might be right around the corner: oil prices surpassing $100 a barrel.
Fueled by supply constraints from major oil-producing nations such as Saudi Arabia and Russia, and coupled with an unexpected display of resilience in the U.S. economy, oil prices have skyrocketed, rising by nearly 30% since June.
The WTI-graded crude, as tracked by the United States Oil Fund ETF
Mark Zandi, the chief economist at Moody's Analytics, has expressed growing concern over this development. He told Bloomberg that sustained oil prices above $100 per barrel could have major implications on the global economy.
Inflation Threat And Federal Reserve Response
The resurgence in oil prices is once again posing a threat to overall inflation. In August, the U.S. monthly inflation rate rose by 0.6%, the most since June 2022, primarily driven by increasing gasoline prices at the pump.
Energy currently holds a 7% weighting in the U.S. Consumer Price Index (CPI) basket, with gasoline accounting for approximately 3.4% of the index.
Over the past 18 months, there have been a series of interest rate hikes totaling more than five percentage points. As a result, there is widespread anticipation that Federal Reserve Chair Jerome Powell and his colleagues will maintain the status quo at their upcoming two-day meeting commencing this Tuesday.
Investors largely expect the Fed to keep rates steady, with a 99% probability currently priced in by the markets, according to CME Group's Fed Watch tool. All eyes will be on the next move, closely scrutinizing the central bank's steps at the Nov. 1 meeting.
As oil prices approach the $100 mark and potentially stabilize at this level, it could present a significant challenge for the Federal Reserve to refrain from raising interest rates once more.
Unpredictability And Ripple Effects
Lindsey Piegza, the chief economist for Stifel Financial Corp., highlights the unpredictability of the situation. She tells Bloomberg that energy costs have emerged as one of the major wild cards currently confronting the Federal Reserve.
Traditionally, the Federal Reserve has tended to downplay the influence of elevated oil prices on inflation, often considering the impact to be transitory.
However, this perspective also has its pitfalls, particularly in overshadowing the ripple effects stemming from a substantial and prolonged surge in energy prices, as observed in 2021.
A Dallas Fed study indicates that a scenario with $100 oil would have a significant short-term impact on headline inflation, with a year-over-year increase of 1.8 percentage points, other things being equal.
In recent years, we've witnessed how sharp increases in energy prices can profoundly impact both bond and equity markets, and the potential for a repeat of the 2022 market turbulence is looming as mounting inflation pressures may force the Federal Reserve to raise interest rates, directly challenging the expectations of rate cuts in 2024.
Consequently, the fate of both bonds and stocks now hinges on the behavior of crude oil.
