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Rising Oil Prices and The Impact on Inflation and the Economy

| May 18, 2018
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The price of gasoline is approaching a four-year high. The United States and the global economy has benefited from lower energy prices. In fact, the current global synchronized expansion can be traced back to the plunge in energy prices at the end of 2015, bringing gas down below $2.00 per gallon for a short while.

So, what do these higher prices mean for the economy and the current expansion cycle? It depends. In the short run it means inflation is getting a push as energy makes up 8.7% of the consumer price index (CPI). Energy is also an input cost to the business cycle. So, depending on how high and how long the prices stay elevated it could become problematic.  CPI as of April is up 2.4%. You can see this playing a little havoc in the bond markets.

With the tightening labor market there is concern we may see wage inflation next. Currently wage growth is up 2.6%, though this is still below the average wage growth of 3.3% during the period of 1990-2010.  So, for now it may not translate into too much inflation, but we will need to keep an eye on wages.

The other component of the inflation picture is the dollar. The dollar has had a decline from its peak in 2017. If the dollar continues to decline this could put additional upward pressure on energy prices. If the economy grows fast enough then we could handle more inflation for a period. If growth were to slow while experiencing a rise in inflation, this might be a cause for concern that the expansion is closer to the end than we believe it is today.

With new sanctions on Iran and concern over rising tension in the Middle East there is always a premium embedded in the price of energy related to a sudden disruption of oil supply. However, the rig count goes up the moment oil goes above $60 a barrel. This means more crude will soon be added to supply and should help keep the lid on the price longer term.

Amid rising tensions in the Middle East and shifts in U.S. policy towards Iran bringing with it new sanctions, we can expect a premium to be added to the price of oil to compensate for the risk of surprise disruptions. This risk premium is likely to remain elevated for some time. However, one mitigating factor should be the ability of oil companies, especially those in the United States, to pump more crude adding additional supply to the market. This important reality should, in our opinion, keep oil prices from rising too much further.

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