You knew about oil prices, discussed in a previous post. Now attention is turning to the sharp rise of long-term interest rates. From Ian Smith, Sam Fleming, and Olaf Storbeck in the Financial Times:
Thanks America for the most idiotic war to date. Iran now controls the Straits, will make it a toll facility for ships crossing and reap the revenue, congrats to the new regional hegemon. Meanwhile the US faces strategic defeat, has dealt a terrible economic blow to poor countries which will result in people in dying needlessly. Keep up the Great Work!
Countries are learning to cut back on energy use. China is even helping other Asian countries with oil. It ain't over till it's over. We'll see who has the best war technology. Surprising to see how many people would like to see Israel nuked.
The negative supply shock in oil is happening alongside a war spending driven expected positive supply shock in Treasuries. Agree in expectation that we’ll likely get more inflation than slowdown due to oil shock. Also agree with the consensus that Asian nations who import a very high percentage of their energy needs from the ME will be impacted more severely as rationing and other forms of demand response to higher prices kick in.
The expected supply increase in Treasuries is part of the recent selloff. As you and others point out, inflation curves look benign. Also the 2y -10y and 2y-30y spreads not really flashing much signal either. Will be interesting to see how Congress handles the expected request for $200b or more for Defense / War dept. and any new estimates around ongoing spending
it is interesting that media and pundits keep comparing to 2022 where the combined fiscal profligacy and loose monetary policy induced a demand shock. it seems to me here we are in a complete different scenario with a supply shock that is destroying demand. so the bond market reaction seems an overshooting unless bond vigilantes are truly back and sending a clear message about not monetizing debt. Most probable scenario will likely be CBs owning public debt and let inflation run above targets. Ordinary citizens will pick up the tab but nothing different from the last 100 years.
There were two huge energy supply shocks in 2022…obviously Putin invading Ukraine but then also TX/Louisiana getting hit with a series of unprecedented weather events beginning in August 2020 and going through August 2021 and then mercifully the huge hurricane in 2022 turned towards Florida.
The fiscal profligacy took place in 2020 and was due to Trump’s lack of oversight of PPP which resulted in upwards $250 billion in fraud that led to the fentanyl OD spike and violent crime surge as it was essentially venture capital for criminal organizations. Biden’s spending is what got us back to full employment quickly with an assist from Trump’s spending and Operation Warp Speed. Biden’s spending also reduced the debt ratio and unfortunately Republicans blocked more spending after 2022 that could have reduced the debt even more. Now we are back to an increasing debt ratio thanks to Trump’s counterproductive tax cuts.
It will be interesting to see next year's defense budget. Allot of high-end missiles are going to be bought, along with extended periods in the shipyards to perform extensive maintenance on our warships. Just the rambling thoughts of an old hermit.
After a decade in commodity trading and risk management, this is one of the cleanest treatments of the supply shock policy dilemma I've read anywhere, and the framing of why central banks struggle when the conventional demand-side toolkit doesn't fit the problem captures something most current commentary refuses to acknowledge. The 1979 credit controls comparison is particularly sharp.Professor Cochrane's point about the political economy of restrictive monetary policy during a supply-driven crisis is the part that deserves more attention than it's getting in current Fed coverage. The institutional incentive to "do something" with stimulus when the actual problem requires restraint is exactly the failure mode that produces the worst outcomes, and the historical pattern is unambiguous.The piece I'd add from the physical commodity side is operational color on why the supply shock is harder to wait out than financial markets currently assume. The inflation impulse from the current crisis is already locked into the supply chain through contractual mechanisms that operate on 60 to 90 day lags. The freight surcharges have been renegotiated. The fertilizer purchases that determine fall harvest costs have been priced at current natural gas levels. The refining contracts have been signed at elevated crude prices. None of this reverses if the Hormuz situation resolves tomorrow, because the contracts are already in place and will flow through to consumer prices over the next two quarters regardless of where spot commodity prices trade. This timing characteristic matters for the bond market analysis in the post because it suggests the market may be pricing exactly what your Treasury graphs are showing. If the lower line is forecasting higher real interest rates rather than a direct inflation premium, the market is implicitly pricing the Fed's eventual restrictive response to inflation that's already in motion through the supply chain. The market knows the inflation is coming through commodity transmission. The Fed's interregnum is preventing it from acting on what the supply chain has already determined. The watch item from the physical side that connects to your Treasury market framework: dated Brent assessments and freight rate indices are leading indicators for the CPI prints that will arrive 60 to 90 days later. When dated Brent stays elevated and the dated Brent versus front-month futures spread remains wide, the supply chain is locking in additional inflation that financial markets are only beginning to acknowledge. The Treasury market is starting to price this. The policy response hasn't caught up. The post's broader point about always reading the axes is the kind of analytical discipline that separates serious work from headline reaction, and it's one of the things I appreciate most about The Grumpy Economist. Sophisticated framing combined with willingness to puncture overstated narratives is rare in current macro commentary.
Good analysis. Economic commentators in the mainstream media tend to see one or two weeks ahead, at most. Serious economists' time frame is measured in years. I would add two things. First, the lags you mention relate to spot prices that already reflect what participants expect will happen in 60 to 90 days. It's quite possible that there are provisions in contracts that provide some hedging. Oil futures are in backwardation, which means that market participants are betting on a sharp fall in oil prices, so you can actually get a glimpse of what inflation (of which oil prices are only a modest fraction) will look like in one or two quarters. Things get more serious if oil prices remain high over a period long enough to affect the entire production chain and, eventually, wage negotiations. I don’t think we’re there yet. Second, it will take courage for central bankers, especially the Fed and the ECB, to resist pressure to lower interest rates, while avoiding the temptation to curb inflation by increasing rates too much. As long as long-term expectations remain anchored at the target—which they currently are—there's really no reason to increase rates for now. As for governments, John’s post on the fiscal/inflation interaction after an oil shock says what one needs to know. I would consider trying to come up with "targeted, timely, and temporary" measures to alleviate the short-term effect of energy prices on lower-income consumers. There's an interesting voucher system used in some European countries: you get an automatic VAT rebate up to a certain monthly amount when filling your tank with gasoline. This is a blunt instrument but, if the rebate is well calibrated, it gets the job done because heavier gasoline consumers (who are typically higher-income) are still responsive at the margin to the price of gasoline, while lower-income consumers get some relief for their day-to-day activities. In Portugal, this worked as intended, and the measure was swiftly removed once it was no longer necessary.
Thanks America for the most idiotic war to date. Iran now controls the Straits, will make it a toll facility for ships crossing and reap the revenue, congrats to the new regional hegemon. Meanwhile the US faces strategic defeat, has dealt a terrible economic blow to poor countries which will result in people in dying needlessly. Keep up the Great Work!
Yeah, but something something wokeness something something deep state!
Wait and see what happens to a suicidal regime that was allowed and pasified for 47 years
Gee, I wish I had your crystal ball.
Countries are learning to cut back on energy use. China is even helping other Asian countries with oil. It ain't over till it's over. We'll see who has the best war technology. Surprising to see how many people would like to see Israel nuked.
The negative supply shock in oil is happening alongside a war spending driven expected positive supply shock in Treasuries. Agree in expectation that we’ll likely get more inflation than slowdown due to oil shock. Also agree with the consensus that Asian nations who import a very high percentage of their energy needs from the ME will be impacted more severely as rationing and other forms of demand response to higher prices kick in.
The expected supply increase in Treasuries is part of the recent selloff. As you and others point out, inflation curves look benign. Also the 2y -10y and 2y-30y spreads not really flashing much signal either. Will be interesting to see how Congress handles the expected request for $200b or more for Defense / War dept. and any new estimates around ongoing spending
it is interesting that media and pundits keep comparing to 2022 where the combined fiscal profligacy and loose monetary policy induced a demand shock. it seems to me here we are in a complete different scenario with a supply shock that is destroying demand. so the bond market reaction seems an overshooting unless bond vigilantes are truly back and sending a clear message about not monetizing debt. Most probable scenario will likely be CBs owning public debt and let inflation run above targets. Ordinary citizens will pick up the tab but nothing different from the last 100 years.
There were two huge energy supply shocks in 2022…obviously Putin invading Ukraine but then also TX/Louisiana getting hit with a series of unprecedented weather events beginning in August 2020 and going through August 2021 and then mercifully the huge hurricane in 2022 turned towards Florida.
The fiscal profligacy took place in 2020 and was due to Trump’s lack of oversight of PPP which resulted in upwards $250 billion in fraud that led to the fentanyl OD spike and violent crime surge as it was essentially venture capital for criminal organizations. Biden’s spending is what got us back to full employment quickly with an assist from Trump’s spending and Operation Warp Speed. Biden’s spending also reduced the debt ratio and unfortunately Republicans blocked more spending after 2022 that could have reduced the debt even more. Now we are back to an increasing debt ratio thanks to Trump’s counterproductive tax cuts.
It will be interesting to see next year's defense budget. Allot of high-end missiles are going to be bought, along with extended periods in the shipyards to perform extensive maintenance on our warships. Just the rambling thoughts of an old hermit.
After a decade in commodity trading and risk management, this is one of the cleanest treatments of the supply shock policy dilemma I've read anywhere, and the framing of why central banks struggle when the conventional demand-side toolkit doesn't fit the problem captures something most current commentary refuses to acknowledge. The 1979 credit controls comparison is particularly sharp.Professor Cochrane's point about the political economy of restrictive monetary policy during a supply-driven crisis is the part that deserves more attention than it's getting in current Fed coverage. The institutional incentive to "do something" with stimulus when the actual problem requires restraint is exactly the failure mode that produces the worst outcomes, and the historical pattern is unambiguous.The piece I'd add from the physical commodity side is operational color on why the supply shock is harder to wait out than financial markets currently assume. The inflation impulse from the current crisis is already locked into the supply chain through contractual mechanisms that operate on 60 to 90 day lags. The freight surcharges have been renegotiated. The fertilizer purchases that determine fall harvest costs have been priced at current natural gas levels. The refining contracts have been signed at elevated crude prices. None of this reverses if the Hormuz situation resolves tomorrow, because the contracts are already in place and will flow through to consumer prices over the next two quarters regardless of where spot commodity prices trade. This timing characteristic matters for the bond market analysis in the post because it suggests the market may be pricing exactly what your Treasury graphs are showing. If the lower line is forecasting higher real interest rates rather than a direct inflation premium, the market is implicitly pricing the Fed's eventual restrictive response to inflation that's already in motion through the supply chain. The market knows the inflation is coming through commodity transmission. The Fed's interregnum is preventing it from acting on what the supply chain has already determined. The watch item from the physical side that connects to your Treasury market framework: dated Brent assessments and freight rate indices are leading indicators for the CPI prints that will arrive 60 to 90 days later. When dated Brent stays elevated and the dated Brent versus front-month futures spread remains wide, the supply chain is locking in additional inflation that financial markets are only beginning to acknowledge. The Treasury market is starting to price this. The policy response hasn't caught up. The post's broader point about always reading the axes is the kind of analytical discipline that separates serious work from headline reaction, and it's one of the things I appreciate most about The Grumpy Economist. Sophisticated framing combined with willingness to puncture overstated narratives is rare in current macro commentary.
Good analysis. Economic commentators in the mainstream media tend to see one or two weeks ahead, at most. Serious economists' time frame is measured in years. I would add two things. First, the lags you mention relate to spot prices that already reflect what participants expect will happen in 60 to 90 days. It's quite possible that there are provisions in contracts that provide some hedging. Oil futures are in backwardation, which means that market participants are betting on a sharp fall in oil prices, so you can actually get a glimpse of what inflation (of which oil prices are only a modest fraction) will look like in one or two quarters. Things get more serious if oil prices remain high over a period long enough to affect the entire production chain and, eventually, wage negotiations. I don’t think we’re there yet. Second, it will take courage for central bankers, especially the Fed and the ECB, to resist pressure to lower interest rates, while avoiding the temptation to curb inflation by increasing rates too much. As long as long-term expectations remain anchored at the target—which they currently are—there's really no reason to increase rates for now. As for governments, John’s post on the fiscal/inflation interaction after an oil shock says what one needs to know. I would consider trying to come up with "targeted, timely, and temporary" measures to alleviate the short-term effect of energy prices on lower-income consumers. There's an interesting voucher system used in some European countries: you get an automatic VAT rebate up to a certain monthly amount when filling your tank with gasoline. This is a blunt instrument but, if the rebate is well calibrated, it gets the job done because heavier gasoline consumers (who are typically higher-income) are still responsive at the margin to the price of gasoline, while lower-income consumers get some relief for their day-to-day activities. In Portugal, this worked as intended, and the measure was swiftly removed once it was no longer necessary.
Graphic discussion, John...
“An oil price shock does not necessarily mean inflation.”
This is a bad take. Energy is the basis of all production and distribution. When energy costs rise, so dies everything else.
The 1973 & 1979 energy shocks caused eight years of stagflation
This is already bigger than that.
So, inflation is coming