Oil, Inflation & the Federal Reserve

Global financial markets continue to be impacted by everything President Trump says and does. This week’s chart focuses on arguably the world’s most important commodity – oil. The chart goes back to the beginning of this year and highlights the impact the Iranian conflict has had on the price of oil. From the start of the conflict in February until the first ceasefire was announced (April 8^th), the price of WTI increased from the mid U.S. $60 range to a peak near U.S. $110. The oil market then began to discount the probability of an agreement (memorandum of understanding) which was announced on June 17^th. As you can see, this agreement was short-lived with the ceasefire ending on July 8^th.

The price of oil influences the price of almost everything because it impacts the cost of shipping goods around the world (e.g. diesel, jet fuel, gasoline, etc.). Oil also has a direct impact on the cost of producing many consumer goods such as chemicals, plastics, etc. For this reason, the price of oil can impact inflation expectations which directly impact interest rates. Higher oil prices not only impact inflation expectations but have also been linked to recessions in the past because they reduce the amount of money consumers have left to spend on other goods – discretionary spending drops as consumers need to purchase groceries and operate their vehicles regardless of the price of oil. The outlook for inflation and interest rates was relatively benign prior to the U.S. & Israel launching their military operation against Iran and would likely be so again if an agreement can be reached to open the Strait of Hormuz.

Yet another related factor to consider is President Trump’s approval rating as we approach U.S. mid-term elections in November. His approval rating is currently at its lowest point in either of his two presidential terms with inflation being one of the largest factors working against him. The American people aren’t buying the Trump administration’s view that tariffs aren’t having an impact on inflation and with this week’s increased tariffs on Canada (America’s largest trading partner) and Canada’s announced retaliatory tariffs, inflation expectations in the U.S. are most likely to increase. President Trump needs a win heading into November as the odds of the Republican Party losing control of both the House of Representatives and the Senate are increasing. Achieving a deal with Canada, Iran or both in coming months would be ideal for President Trump and the Republican Party.

President Trump has a lot of balls in the air and to complicate matters further, he recently hired a new Chairman of the Federal Reserve which sets monetary policy (e.g. interest rates) in the U.S. Kevin Warsh was appointed Chairman of the Federal Reserve on May 22^nd of this year with the mandate of reforming the Federal Reserve and reducing inflation to the Central Bank’s target of 2% which hasn’t been achieved since prior to the COVID pandemic. President Trump effectively fired Kevin Warsh’s predecessor, Jerome Powell, for not reducing interest rates further and has now tied the hands of the newly appointed Warsh through a trade war with Canada and a failed regime change in Iran. The U.S. bond market is currently discounting between one and two interest rate increases for the remainder of this year based on inflation expectations remaining stubbornly above the 2% target. President Trump can change this with the stroke of a pen (reaching an agreement with either Iran or Canada). Only time will tell if either occur, however, Trump must be motivated not to become a ‘lame duck’ by loosing control of both the House and Senate in November.