West Texas Intermediate (WTI) oil was down to $64 per barrel last week before the Iran war.
Today, WTI is close to $74 per barrel – a whopping 16% increase that will work its way into every other thing we purchase.
This is because the war threatens the supply and transportation of a huge portion of the world’s oil and liquid natural gas (over 20%).
Gasoline prices are already up 20 cents per gallon – the largest jump we’ve seen over a short period in over 20 years.
Renowned analyst and inflation hawk, Jim Bianco, expressed his alarm today in this post.
Bianco points out how much gas prices influence CPI (inflation readings), and how this bump in gas prices could push CPI up by almost 0.3%.
In other words, expect a higher CPI print – and higher rates as a result, as nothing spooks the Fed and the bond market more than hot inflation readings.
BUT – it won’t last – and this is why.
Supply Shocks vs. Inflation – The Single Biggest Source of Confusion in Economics
Bianco confuses transitory price increases (resulting from supply shocks) with structural inflation resulting from an increase in the money supply.
Transitory price increases usually resolve themselves – when the supply restrictions (the war in this case) end or when additional supply hits the market from other sources in reaction to higher prices (something that energy analyst Doomberg says we always see).
NOTE: This is partly why the Fed was reluctant to raise rates as COVID wound down; it was not sure whether the price rise was due to COVID supply shocks (because of shutdowns) or to an increase in the money supply. Raising rates to fend off supply shock inflation serves little purpose. Turns out, though, that the inflation was “structural”/caused by a massive increase in the money supply – and the Fed missed the boat (again).
Three Takeaways
- RATES WILL STILL FALL: This will keep rates higher than they otherwise would be until the war ends and for some time after that, but that does not mean that rates will not keep falling (it just means they will fall less than they otherwise would have).
- PRICE INCREASES ARE TEMPORARY: These price increases and inflation fears will not last, unless the war and the shipping lane shutdowns drag on for a lot longer than expected.
- DON’T PAY DISCOUNT POINTS: Borrowers should not pay points to buy down their interest rates, as many analysts, e.g. Ed Dowd and Chris Whalen, expect rates to fall irrespective of temporary supply shock inflation. If borrowers pay points for a lower rate now but still end up refinancing in six months if rates fall, they will have wasted their money.
