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    Instant Insights: Quantifying oil’s impact on CPI

    Instant Insights: Quantifying oil’s impact on CPI

    March 10, 2022 Fixed income

    CPI recorded another multi-decade high, albeit this time in line with expectations at 7.9% year-on-year, while Core CPI was 6.4%.

    In our view, the recent oil price spike increases the possibility of CPI remaining above 5% for the rest of the year, although we do not expect it to cause inflation to spiral further upwards.

    "Sticky" inflation categories slow down

    In previous Instant Insights, we have stressed the importance of watching how the “sticky” CPI components are evolving to gauge the persistence of inflation, particularly after the sticky healthcare category accelerated last month.

    Notably, healthcare inflation moderated this month (Table 1). Elsewhere, in the shelter categories, owner’s equivalent rent maintained its recent pace at 0.4%, while rents accelerated to a more concerning 0.6%.

    We continue to believe that acceleration in the ‘flexible" inflation categories is far less sustainable, and within these categories, used car prices actually fell for the first time since September. However, airfares accelerated – likely due to rising fuel costs.

    Table 1: Rents saw the largest gain within the sticky categories, while airfares saw the largest gain in flexible categories 1

      Sticky categories
      Health services Owners equivalent rent Rents Education and
    Dec-20 -0.1% 0.2% 0.1% 0.1%
    Jan-21 0.5% 0.1% 0.1% 0.1%
    Feb-21 0.4% 0.2% 0.2% 0.1%
    Mar-21 0.1% 0.2% 0.3% 0.0%
    Apr-21 0.0% 0.2% 0.4% 0.2%
    May-21 -0.1% 0.3% 0.3% 0.2%
    Jun-21 0.0% 0.3% 0.5% 0.1%
    Jul-21 0.2% 0.3% 0.4% 0.1%
    Aug-21 0.2% 0.3% 0.2% 0.2%
    Sep-21 0.2% 0.4% 0.4% 0.3%
    Oct-21 0.4% 0.4% 0.4% 0.2%
    Nov-21 0.3% 0.4% 0.5% 0.1%
    Dec-21 0.3% 0.4% 0.4% 0.1%
    Jan-22 0.6% 0.4% 0.4% 0.1%
    Feb-22 0.1% 0.4% 0.6% 0.1%


      Flexible Categories Non-core Categories
      Airfare Used cars Apparel Food Energy
    Dec-20 -2.7% -1.1% 0.5% 0.3% 3.7%
    Jan-21 -1.8% -0.9% 1.4% 0.2% 2.8%
    Feb-21 -2.1% -0.7% -0.5% 0.1% 4.6%
    Mar-21 0.9% 0.3% 0.4% 0.2% 5.6%
    Apr-21 10.0% 9.8% 0.6% 0.4% -1.2%
    May-21 8.8% 7.7% 1.1% 0.5% 0.7%
    Jun-21 0.9% 10.1% 0.5% 0.7% 2.1%
    Jul-21 -3.3% 0.0% 0.1% 0.7% 1.6%
    Aug-21 -8.6% -1.2% 0.3% 0.4% 1.9%
    Sep-21 -5.9% -0.5% -0.7% 0.9% 1.2%
    Oct-21 -1.1% 2.5% 0.6% 0.9% 3.7%
    Nov-21 1.9% 2.4% 0.7% 0.8% 2.4%
    Dec-21 2.5% 3.3% 1.1% 0.5% 0.9%
    Jan-22 2.3% 1.5% 1.1% 0.9% 0.9%
    Feb-22 5.2% -0.2% 0.7% 1.0% 3.5%


    The oil spike may prolong high energy inflation trends, but is unlikely to cause them to accelerate further

    Russia’s war in Ukraine has added considerable uncertainty to the inflation outlook, particularly as commodity markets have been most directly impacted.

    Domestically, we have all been feeling the pinch from gasoline prices surpassing $4.25 per gallon, a new record, since the invasion. Further restrictions on Russian energy supply, either through sanctions or withheld exports, present further upside risks. On the flipside, de-escalation would likely allow prices to fall materially.

    The good news is the feed-through to energy CPI may not be quite so dramatic – at least with regards to year-on-year figures. This is because energy inflation was already running high relative to a year ago. Even if oil spikes to $150 per barrel (a scenario that would potentially require Russian oil exports falling to zero), our analysis implies energy inflation would remain constant. If oil prices remain around current levels or fall, energy inflation would potentially fall due to base effects (Figure 2).

    Figure 1: Spiking oil prices may not have a dramatic effect on energy CPI due to base effects 2


    CPI may not slow quite as much into the year-end as previously expected

    Energy is a material component of CPI, comprising ~8% of the index. It also has key second round impacts on airfare and other transportation costs. It is also a key determinant of fertilizer and food prices.

    If our central case is for the oil futures curve to play out (i.e., WTI Crude Oil ends the year between $90 and $110), it would leave our CPI projection at ~3.5%, a marked fall from today’s print but still above the Fed’s target (Figure 3).

    Figure 2: Energy risks could mean CPI ends the year well above the Fed’s target 3


    The risk case, with oil prices ending the year at $150 per barrel, would imply CPI ending the year above 5% year-on-year – still a slowdown from current levels but far above the Fed’s target. At such levels, real disposable incomes and real wages will potentially turn negative, eroding personal savings and creating significant economic headwinds.

    The energy spike makes the Fed’s job harder

    The Fed is stuck between both the inflationary and economic pressure presented by rising energy prices. As such, markets will watch next week’s FOMC meeting closely. Policy rate “lift-off” is expected, alongside the Fed’s latest quarterly projections.

    Geopolitical risk has added a new wrinkle to the inflation picture, skewing risks toward CPI staying higher for longer. Nonetheless, we believe the domestic US economy currently looks well-placed to weather the strain given a healthy buffer of consumer savings and domestic production, whereas Europe and energy-importing emerging market economies look more exposed.

    As such, we believe corporate bond investors need to stick to carefully-underwritten credits, potentially paying particular attention to those exposed to the domestic economy given recent spread-widening.

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