Inflation’s Big Comeback: The Only Thing Keeping It in Check is About to Give Way

August 25, 2023

It was a banner week in the news!

India landed on the moon!

India parked an unmanned probe, equipped with a lunar rover, on the south pole of the moon. (This came just days after a Russian attempt crashed and burned… or whatever crashing spacecraft do in space.) The mission is to search our satellite for sources of water.  

In other news, Russian oligarch Yevgeny Prigozhin was killed when his private jet crashed (foul play is almost certain).

If you don’t remember, he’s the leader of the Wagner paramilitary group who made the incomprehensibly bad career move of leading his troops against Moscow to demand the ouster of Russian Defense Minister Sergei Shoigu.

Then there was this…

The Journal was one busy news outlet. 

There was, however, one item of some interest that wasn’t trumpeted anywhere on their August 22 front page…

Ratings agency Standard & Poor’s downgraded five regional banks and lowered their outlook for two more.

Granted, downgrades are becoming commonplace these days. I wrote about them here last week. But still, you’d think it would merit some prominent digital ink in the Journal. (To be fair, they did post a very brief blurb on their “Live Coverage Feed.”)

The cause of the action by S&P was “high commercial real estate (CRE) exposure.” Again, something we warned you about before.

Still, while the headline didn’t seem to rate above the pet amenities story, it is significant. Regional banks, a critical part of our financial system, have been getting hammered since March this year. Their brief rebound was abruptly stalled when Moody’s cut 10 banks on August 8…

SPDR S&P Regional Banking ETF (KRE) — August 8


That was a reversal they still haven’t recovered from…

SPDR S&P Regional Banking ETF (KRE)


The trend of lowered ratings, even inching down like they are, represents a weakening in the economy. 

Ignore it and it will become like the boiling frog story. You don’t notice your surroundings getting hotter until you’re cooked!

So even though the Journal missed it… it’s not insignificant.

The Other Elephant Still In the Room

As troubling as that is, it’s not the only thing posing a problem to the country’s economic engine. Inflation is still a major problem. And there is reason to believe that it could start to heat up again. 

It’s something Jay Powell and the rest of his Fed colleagues would rather not think about. So far this year the headline CPI number has been a sight for sore eyes. The prints have shown a slow down in the rate of inflation for 12 straight months. (Remember, that’s the rate of inflation — how much prices have been rising. Prices are still at all time highs and still going higher!)

The last report for July, however, showed a slight uptick from 3% to 3.2%.

That’s the “headline” number. The “core” number is a different, and more important story.

I’m sure you know the core measure of inflation excludes food and energy prices. The claim for this adjustment is that food and energy prices are too volatile and they skew the index. Some say it’s dumb to exclude the two most important things people buy, but it’s true… they are volatile and they do influence the index.

The problem these days is, they’re not skewing inflation numbers higher… they’re actually skewing them lower!

In July headline inflation was up 3.2% but its core cousin was up 4.7%. Take out food and energy and the calculation actually goes up. That means it’s food and energy prices that have been bringing the index down! 
And it’s not even both of them. Take a look…

Source: US Bureau of Labor Statistics

Overall food, with an index weighting of 13.4, was up 4.9%. Energy, on the other hand, was down 12.5% and it only has a weighting of 6.9 — half that of the food component. 

This essentially means that energy was doing all the heavy lifting keeping headline inflation in check. 

Indeed, if you break the category’s components down — fuel oil fell 26.5%, gas was down 19.9%, gas services were down 13.7% — you can see the huge declines in energy prices that have impacted the overall number. 

Without their influence, inflation is still running at just under 5%.

And if the retreat in energy prices stops, and they were to start rising again… well then we’ve got a real problem.

What Could Cause That Shift?

In a word (two actually): supply and demand.

Energy products are commodities and like all commodities they are subject to the two market forces. And another thing about them — they are absolutely necessary. There’s little price elasticity when it comes to energy.

Today, all the talk about our green future is just that — talk. “Net Zero” by 2030 or 2040 or whenever is a pipe dream. It’s fine to have goals of more efficient, more cost-effective, more environmentally friendly energy sources. But the reality we live in is that we are a fossil fuel based economy. And there is nothing that can replace that at scale anywhere in the near future. 

So oil and all the energy products that are made from it are still the thing.

December ‘23 Crude Futures (Nearby contract)


Taking a look at the chart above, you can see that oil prices have settled into a range between $65 and $85 since they came off 2022’s highs. For the past month and a half, prices have pushed back to the upper end of the range testing $85 in the last two weeks.

So what do these two driving forces behind the market look like? 

Demand is Still Strong

In general the mood is that demand for oil has remained strong because we haven’t tipped into a recession. In fact, much of the pessimism over future growth has turned more optimistic. 

According to Reuters:

Goldman analysts estimate global oil demand climbed to an all-time high of 102.8 million barrels per day (bpd) in July and see solid demand driving a larger-than-expected 1.8 million bpd deficit in the second half this year and a 0.6 million bpd deficit in 2024.

According to Exxon Mobil:

One lurking factor that could mitigate this somewhat is China. The Chinese economy has been under stress of late and may be susceptible to a recession of their own. Economic trouble there would ease global demand… somewhat.

The other side of the coin is supply — which has been shrinking while demand has been expanding. 

Back in July, OPEC+ cut production by one million barrels per day. The WSJ noted:

The output cut adds to a reduction of 2 million barrels a day agreed to in October by the Saudi-led Organization of the Petroleum Exporting Countries and a group of other producers led by Russia. Taken together, the output cuts amount to about 3% of the world’s petroleum production taken off the market in seven months.

Earlier this month they announced they would maintain the production cut through September.

“Saudi Arabia will extend the voluntary cut of one million barrels per day, which has gone into implementation in July, for another month to include the month of September that can be extended or extended and deepened,” the Saudi Press Agency reported on Thursday, citing an official source from the Ministry of Energy.

Domestic production, something the current administration seems to have no interest in, is falling off too.

The total oil rig count in the US fell to 520 the week of August 18.

And at the end of July, oilfield servicers Halliburton and Baker Hughes indicated they were seeing softer demand for drilling on the North American market.

Rising demand into a monthly production deficit can only lead to one outcome…

A Resumption in Rising Prices

These developments have caused some analysts to take note. According to

Others are seeing the potential for even higher prices:

Crude oil prices could be on track to hit $100 and even $120 per barrel, which calls for aggressive buying moves into the oil market now, Cole Smead, president and portfolio manager at Smead Capital Management, told BBN Bloomberg on Wednesday.

It’s worth keeping an eye on the price of oil. Should West Texas Intermediate (WTI — the US benchmark) breakout above the $85 level, significantly higher prices would be likely. And if energy prices start to spike, the only thing holding inflation in check will be out of the box, and headline prices will be soaring once again.

That scenario puts the Fed in a tough predicament. Jay Powell has said over and over and over that price stability is the foremost objective of the Fed. They’ve slowed their pace of rate hikes for most of this year trying to figure out if they’ve gotten to “restrictive” yet. But another spike in inflation would almost certainly lead to more aggressive hikes this year. 

“It would be foolish for any central bank to declare victory,” Randall Kroszner, a former governor of the US Federal Reserve System and now an economics professor at the University of Chicago Booth School of Business, told CNN.

And that brings us back to our struggling regional banks with crumbling credit ratings. It was the aggressive action by the Fed last year that started their troubles. A continuation of that stance will only cause more trouble for them. 

And that leads to another even more significant threat.

I’ll explain what that is in your August issue coming out next week.

Until then…

Humbly yours,

Tim Collins
Editor, Streetlight Confidential