Bloomberg had an interesting piece out on why oil prices threaten the Fed’s mandate to keep rates flat until 2023. The Federal Reserve’s current position is that they have told markets that they are not thinking of hiking interest rates until at least 2023. However, oil pushing higher threatens that approach for the following reasons:

1. Rallying oil increases inflation expectations. The higher energy costs get passed on to the consumer increasing prices. Look at the chart below showing how WTI prices lift inflation.

2. The argument against the Fed reacting is that the Fed see energy costs as ‘transient’(passing), so look through them. However, there is a strong case for rising oil prices remaining:

  • OPEC is determined to cut supply to boost the prices
  • The jump to green energy has caused key oil infrastructure, like Keystone, to be cancelled.
  • As Economies re-open that will cause oil demand to rise, further supporting prices.
  • The new normal now is that higher energy costs are part of the landscape and the Fed is not factoring them in properly.

The takeaway

Remember the Fed’s target is to allow/look for +2.5% inflation and rising oil prices could be the factor that gets it there. That may come far sooner than 2023. Watch out for oil adding inflationary pressures and possibly triggering a taper tantrum. See here to read more on that.