With the Federal Reserve preparing to release updated inflation and interest-rate forecasts on Wednesday, the proverbial elephant in the room will probably be missing from the equation: The full impact of rising oil prices, according to investors, traders and strategists.
Oil prices touched fresh 2023 highs on Tuesday and settled above $90 a barrel, a byproduct of this month’s decision by Russia and Saudi Arabia to extend production cuts into year-end. Just a day ago, Mike Wirth, chief executive of Chevron CVX, -0.01%, put the prospect of oil crossing $100 a barrel on the map and the price at the gas pump went above $6 a gallon in Southern California — reigniting fears about a revival of inflation.
It’s too soon to say whether the run-up in energy prices will spill over into the narrower core inflation gauges that the Fed cares most about, TD Securities strategist Gennadiy Goldberg said via phone. As a result, policy makers may look past the impact of higher energy prices on their longer-term inflation and rate outlook Wednesday, he said. Fed officials are hesitant to place too much weight on energy or food as components of inflation, anyway, because of their volatile natures.
However, some traders are worried that such an omission could be a mistake considering all the other price pressures playing out, such as strikes against the three major U.S. automakers.
“Is it a mistake to not factor in oil? I personally think it is, but I’m probably in the minority on that,” said Gang Hu, an inflation trader at New York-based hedge fund WinShore Capital. “The combination of oil and strikes by the United Auto Workers presents a structurally unstable inflation picture.”
“If the Fed is the one that provides insurance against inflation and is not doing anything, the market will seek inflation protection by itself and it will look like inflation expectations are unanchored. This is the risk,” Hu said via phone.
Nervousness around the prospect of a higher-for-longer message on rates from the Fed helped send the 2- BX:TMUBMUSD02Y and 10-year Treasury rates BX:TMUBMUSD10Y to their highest levels in more than a decade on Tuesday. The ICE U.S. Dollar Index was off by less than 0.1%.
Investors and traders are expected to zero in on the part of the Fed’s Summary of Economic Projections that reflects where the fed-funds rate target, currently between 5.25%-5.5%, could go in 2024. As of June, policy makers penciled in the likelihood of four 25-basis-point rate cuts next year after factoring in more tightening this year, and they saw inflation creeping down toward 2% in 2024 and 2025, as well as over the longer run.
Many in financial markets are clinging to the likelihood of no Fed rate hike on Wednesday, and see some possibility of just one more increase in November or December before rate cuts begin in the middle or final half of next year. But inflation traders now foresee seven straight months of 3%-plus readings on the annual headline CPI rate, from September through next March; that’s up from five consecutive months seen as of last Wednesday and complicates the question of where the Fed will go from here.
“The Fed’s rate decision on Wednesday was already decided a while ago, when officials started to communicate that a pause would be the likely outcome,” said Mark Heppenstall, chief investment officer of Penn Mutual Asset Management in Horsham, Pa., which oversaw $32 billion as of August.
“On the margin, we might see higher oil prices make a modest impact on rate projections,” he said via phone. However, “it’s too early for the story to change on disinflation and all the progress made so far.”