Energy-driven inflation is back in focus as the Strait of Hormuz disruption collides with Fed policy expectations.
KEY TAKEAWAYS
The American economy continues to function beneath a loud geopolitical and market news cycle. While energy prices and war headlines dominate attention, the underlying economic engine is still operating with solid employment and resilient consumption.
The CPI release represents the last inflation snapshot before energy price shocks from the conflict begin appearing in official data. Rising gasoline prices will likely influence consumer behavior and inflation expectations in coming months.
Markets are highly sensitive to the idea that rising energy prices could delay Federal Reserve rate cuts. This sensitivity explains why growth stocks often react quickly to oil spikes and inflation fears.
The concept of “core” inflation removes food and energy from the calculation, but households feel those prices most directly. This creates a disconnect between the economic models policymakers rely on and the lived experience of consumers.
Strategic oil reserve releases are being proposed to stabilize markets. However, the physical supply math shows that reserve drawdowns cannot fully offset the massive potential supply loss from Hormuz disruptions.
MY HOT TAKES
Markets often move on psychology before fundamentals. The signal that governments are prepared to intervene can calm markets even when the physical solution is insufficient.
Investors should not confuse supply-shock inflation with demand-driven inflation. Energy-driven price spikes have identifiable causes and typically resolve once the disruption ends.
The Federal Reserve’s focus on core inflation can create policy blind spots. Americans experience inflation through food and fuel prices regardless of how policymakers choose to measure it.
Strategic petroleum reserves function partly as a communication tool rather than a true replacement for lost supply. The signaling effect can stabilize prices temporarily even if the physical math doesn’t work.
Despite geopolitical shocks, the American economy remains resilient. Markets may swing dramatically, but the broader economic machine continues grinding forward.
You can quote me: “Strategic reserves are less about replacing oil and more about replacing fear.”
Math not mathing. Can you see it through all the haze? Can you hear it through all the noise? That’s right, it’s the American economy. You know, the largest one, the world over. It continues to grind while all that other “stuff” clogs the news cycle and your mind. There is no question that “stuff” is impacting your portfolio, so please don’t ignore it, but as I implied strongly in yesterday’s blogpost / newsletter, make sure to keep it in its place. Let’s start out this morning’s discussion with the economy–don’t worry, we’ll be back on the war in a minute.
This morning the Bureau of Labor Statistics (BLS) will release the Consumer Price Index / CPI for January. It is widely noted in this morning’s press as being the last clean, pre-war print of inflation. That is kind of important given the stark rise in energy costs in these past few weeks. We have already seen the effects of that at the pump with the national average of gasoline hitting $3.58. In case you forgot, it was $2.99 on the Friday before the attack two weekends ago. That is bad, really, because it will ultimately affect how we spend money–really. But let’s take a step back and think about why this inflationary pressure has impacted markets.
It starts with the Fed and the market’s unhealthy obsession with rate cuts. The on-the-fence Fed will now be reluctant to cut rates this year due to the threat of fuel-driven inflation. Higher rates for longer? Sell your favorite growth stock. Actually, don’t do that; I added that sentence for dramatic effect. You know the drill, markets are very much in the “love the dove” feels these days. That said, isn't it common wisdom that the Fed’s favorite gauge of inflation is so-called “core” inflation? Core strips out food and energy. Why is that even a thing? I don’t know about you, but the importance of food is pretty high up on my list of “gotta haves”--right under shelter, I think. Fuel is pretty high as well–assuming I want to get to work so I can get paid. My point here is that Americans are extremely sensitive to food and energy costs, and it seems pretty odd that the guys and gals responsible to control inflation would ignore it. But will they ignore it? Well, based on recent Fed banter prior to the black out, NO.
I want to take a brief diversion into history before we move into what the IEA (International Energy Agency) is signaling this morning. It is probably best to begin with a chart of CPI not including this morning’s print. Have a look, then let’s roll.
This is my favorite Bloomberg ECAN chart. I want you to pay attention to the rust-colored bars which represent energy inflation. You can see just how much energy inflation contributed to the runaway headline inflation figure in 2021 and 2022. In 2021, energy prices were on the rise as a result of OPEC cuts (lower supply) and folks returning to work after the COVID lockdowns (higher demand). But 2022 saw the start of the Russian invasion of Ukraine which added a supply shock–lower supply. By late 2022 energy was disinflating and by 2023 it was deflating, meaning, prices were actually going down. If you were looking at core inflation–like the Fed–you wouldn’t have noticed the decline in overall household-sensitive inflation. Now to the history and on to the IEA.
The concept of "core" inflation has its roots in the 1970s, and it wasn't born out of pure academic curiosity. Arthur Burns, Fed Chair during the oil embargo era, became somewhat infamous for systematically stripping out categories that were making the inflation picture look ugly. First it was energy, then food, then used cars, until what remained told a much friendlier story. 🤨 Politicians loved it because it gave them cover during a period when Americans were lining up at gas stations and watching their grocery bills climb. Remember those gas lines? I do! The designation stuck, and to be fair, there is a legitimate analytical argument for looking at underlying demand-driven price trends. But the lived experience of American households has never cared much about financial model elegance. You feel food and fuel every single day. The irony is that when energy was deflating last year and pulling headline CPI below core, nobody in Washington was rushing to the podium to say "ignore headline, look at core–inflation is actually worse than it appears." They were perfectly happy to let the friendlier number do the talking. Now that the dynamic is about to flip with energy pushing headline above core in the coming months, watch how fast the "core is the real number" narrative comes roaring back. You can practically set your watch to it.
Enough of that, now let's talk about what the IEA signaled this morning, because it matters, though perhaps not in the way you might think. The International Energy Agency is reportedly proposing the largest coordinated release of emergency oil reserves in its history, potentially exceeding the roughly 182 million barrels that member nations released in two rounds during the 2022 Ukraine crisis. IEA member states collectively hold about 1.2 billion barrels of public emergency stockpiles with another 600 million in obligated industry reserves. That sounds enormous. It is enormous.
But here is where the math stops mathing.
The Strait of Hormuz, through which roughly one-fifth of the world's oil supply normally flows, remains effectively shut down. That translates to something on the order of 20 million barrels per day of lost supply. The problem is that historically, IEA coordinated stock releases have never exceeded a drawdown rate of about 2 million barrels per day. Most of these reserves sit in underground salt caverns, not in tanks ready to pour. You have to inject water, pump the oil up, move it through pipelines to terminals, and then ship it. That takes time. So, you are looking at a replacement capacity that covers roughly a tenth of what is being lost daily. The math, as I said, is not mathing.
But here is the thing–and this is really important–the math does not have to math for this to work, at least in the short term. We watched crude oil swing from nearly $120 a barrel to under $88 in roughly 24 hours earlier this week. No actual barrels were added to the market. No tankers were rerouted. What happened was a combination of President Trump hinting the conflict might be nearing its end and the IEA signaling its willingness to act. That was a pure psychological move, and the market responded to it like a patient responding to a placebo that they believe is real medicine. The IEA announcement functions less like a traditional supply intervention and more like the oil market's version of forward guidance. Think of it as the energy equivalent of Mario Draghi's famous "whatever it takes" moment during the European debt crisis. The credible threat of coordinated action is doing more heavy lifting than the actual barrels ever could.
That said, psychology has its limits, and this is where I urge you to stay patient and stay focused. If the conflict resolves quickly, the reserve signal will have been enough to keep markets from spiraling, energy prices will settle, and the inflationary impulse fades before it can do lasting damage. If it drags on–and I have been clear about my view that markets may be underpricing the duration of this conflict–then physical reality will eventually reassert itself and no amount of signaling will paper over a sustained supply deficit.
The reserves buy time; they do not buy resolution. That is a critical distinction.
So where does that leave you this morning? The economy beneath all of this noise continues to function. Employment remains solid despite last Friday’s weak print (that is another story for another time), consumer spending has been resilient, and this morning's CPI print, whatever it shows, reflects an economy that was chugging along before the geopolitical shock hit. The inflationary pressure from energy is real and it will show up in the data over the next couple of months, but it is not the same animal as the demand-driven inflation we fought in 2021 and 2022. And, besides, the Fed can’t control supply-shock inflation with interest rates. 😉 This is a supply shock with an identifiable cause and, eventually, an identifiable resolution. So, keep your eyes on the horizon, not on the waves. The American economy has absorbed shocks like this before, and it will absorb this one too.
YESTERDAY’S MARKETS
Stocks whipsawed to and fro yesterday with conflicting signals about the Strait of Hormuz. Beleaguered Oracle reminded us that AI is still healthy after the close–it is nearly 10% higher in the premarket, but it may not be enough to cut through the fog of war.
NEXT UP
Consumer Price Index / CPI (February) is expected to remain unchanged at 2.4%. This number will not reflect the recent energy price hikes.