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We’ve witnessed some signs of positive momentum in the fight against inflation over the past few quarters. While things are not perfect, they are significantly better than a year ago. We need to embrace the positives but must also acknowledge the threats that still lie ahead. Gas prices have been on the rise again and led to some concern about whether inflation may spike once more.
Since mid-June, Brent crude prices have increased by ~30% and are on the doorstep of $100/barrel. Like most things in the past few years, oil prices have been on quite the rollercoaster ride. Last year, prices surged between February and July, which coincided with Russia’s invasion of Ukraine, topping out at ~$128/barrel. Prices leveled off for the remainder of the year but have steadily increased since March.
Oil is vital to the global economy as its price directly impacts consumers and business spending. Generally speaking, a rise in prices leads to an increase in the price of the goods and services we consume. Many refer to this as an invisible tax. Elevated prices over an extended period can slow economic growth and lead to a spike in inflation. For much of the past two decades, inflation was an afterthought, and today, it’s one of the largest threats to the global economy.
It should be stated that much of the decline earlier this year was in anticipation of a weakening global economy. Surprisingly, it has been extremely resilient and hasn’t shown material signs of slowing, which has led to an unexpected spike in U.S. oil production, as seen below.
While a stronger-than-expected economy partially explains the increase in production and prices, the other reason is motivated by geopolitics. Many of the large global oil producers can actively choose when to increase or decrease production to control prices and gain leverage. Just recently, Saudi Arabia and Russia, members of OPEC+, announced additional production cuts in an attempt to prop up oil prices! So, while U.S. production has drastically increased this year, some of this is attributed to large production cuts by OPEC and OPEC+ for the remainder of 2023. There are risks with employing these types of strategies, but countries often use the oil markets as a leveraging tool.
Another worry is the recent decline of U.S. oil inventories. Currently, the Strategic Petroleum Reserve (SPR) is near its lowest level since 1985! Much of the decline in reserves was to help ease the burden of large price increases last year when gas hit over $5 a gallon nationwide. Getting our reserves back to normal will take time, thus making us and oil prices vulnerable to other countries’ actions.
While not ideal, it’s far too early to draw any conclusions. Both CPI (Consumer Price Index) and Core CPI, excluding energy and food prices, have steadily decreased over the past 12 months.
Only recently did CPI experience a slight uptick due to the massive spike in oil prices. Unless oil prices remain elevated for an extended period, the impact on inflation should be minimal. CPI comprises eight major groups, including housing, transportation, and food and beverage. This means that for CPI to increase substantially, multiple groups need to experience sharp increases at the same time.
While rising oil prices are a legitimate concern, it’s too soon to ring the alarm bells. One could argue that elevated prices could eventually drag down economic growth. This, in turn, would likely lead to a dip in inflation, as consumers and businesses would probably spend and invest less capital. While that would be good for inflation, it would be a problem for economic growth. As we know, so much of the economy is intertwined, and the ripple effects from each need to be considered.
The Federal Reserve has made it clear they are pretty much done raising rates but will also be very cautious about cutting them too soon. They want to ensure inflation does not rear its ugly head again and are willing to leave rates higher for longer as long as the economy continues to take it in stride. The unknown question: Just how much longer will that statement hold true?
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