Persistent energy shocks from the Strait of Hormuz are continuing to transmit through the inflation chain, driving U.S. producer prices last month to their highest increase since 2022. This has renewed market concerns regarding the Federal Reserve's interest rate policy outlook. Consumer price data for April, released the previous day, showed inflation had already reached a three-year high. The latest surge in wholesale price figures suggests inflation will continue to rise in the coming months.
Energy Shock Spreads Data released by the U.S. government on Wednesday showed the Producer Price Index (PPI) for April surged 1.4% month-over-month, the largest single-month increase in over four years. This marks the sixth consecutive month of significant PPI increases, far exceeding Wall Street's expectation of 0.5%. Over the past year, U.S. wholesale prices have risen 6.0% year-over-year, doubling the growth rate seen at the start of the year and reaching the highest level since late 2022. The core PPI, which excludes food and energy, accelerated to a 5.2% year-over-year increase from a revised 4% in March, surpassing the expected 4.3% and also marking the highest annual growth rate since December 2022.
As anticipated by the market, rising oil prices were the primary driver of inflation, but not the sole cause. Inflation at the upstream raw materials level was even more striking: unprocessed energy materials surged 9.2% in April, with a year-over-year increase reaching 48.9%. Prices for machinery, commercial equipment, transportation, chemicals, and other goods and services rose simultaneously, highlighting the comprehensive spillover effects of rising energy costs. The final demand trade services margin, which reflects the profit margin between wholesalers and retailers, jumped 2.7% in April. Transportation and warehousing services surged 5.0% for the month, the largest increase in years. Rising freight truck rates show energy costs are significantly transmitting to the logistics sector. "Nearly 60 percent of the April advance in final demand prices is attributable to a 1.2-percent increase in the index for final demand services," the U.S. Labor Department stated. Wholesale prices are a leading indicator of inflation, often signaling the future direction of consumer prices. Data released on Tuesday showed the U.S. Consumer Price Index (CPI) for April rose to 3.8%, a new high for 2023. "April's PPI report shows inflationary pressures continue to heat up. May's CPI could rise again. The U.S.-Iran conflict is pushing up energy prices and spreading to other areas, and inflationary pressures will further diffuse," wrote BMO Capital Markets in a report. "Much of the surge in producer costs is tied to energy prices and has been fully transmitted into goods and services data. This round of inflation shock is likely temporary, as shipping through the Strait of Hormuz will eventually return to normal. The real question is, how much more pressure can the real economy—including consumers and businesses—withstand," said Scott Helfstein, Head of Investment Strategy at Global X ETFs.
Policy Outlook Following the release of the PPI data, the yield on the 2-year U.S. Treasury note, which is highly sensitive to Federal Reserve policy expectations, rose from 3.98% to 4.02%. Pricing in Federal Reserve interest rate futures indicates the market is assigning nearly a 40% probability of a rate hike before December this year. Boston Fed President Susan Collins stated on Wednesday that she envisions interest rates will remain stable for an extended period. However, she also noted scenarios could arise that require a degree of policy tightening to ensure inflation returns to the central bank's 2% target. "This shock has tilted the risks to real activity slightly further to the downside, while tilting inflation risks further to the upside." Meanwhile, the price transmission effects from tariffs, while gradually fading, have not been fully absorbed in goods prices. For the incoming Chair Wash, the timing is extremely unfavorable. With just one month remaining before he chairs his first Federal Open Market Committee (FOMC) meeting as Fed Chair, overall inflation is accelerating once again against the trend. Preliminary real-time forecasts from the Cleveland Fed for May suggest the overall CPI year-over-year rate may climb further to 3.89%. A consensus on Wall Street suggests the price pressures facing consumers will be difficult to alleviate in the short term. The secondary energy shock will become more apparent in the coming months, potentially pushing the inflation rate above 4% in the near term. The future direction of prices will depend on when the U.S.-Iran conflict ends, whether the Strait of Hormuz resumes normal traffic, and the speed of the decline in oil prices. "Currently, there is no clear endpoint to the conflict. The main drivers of inflation—energy, oil, gasoline, transportation, and food—will rise further in the coming months as global supply tightens and supply chain pressures increase," said Joseph Brusuelas, Chief Economist at RSM. Stephen Juneau, an economist at Bank of America, defined April as an inflection point for inflation in a client research note. Brian Jacobson, Chief Economist at Annex Wealth Management, issued a warning: "Inflation is heating up much faster than expected. Currently, the energy shock is impacting corporate profit margins more and has not fully transmitted to consumer prices. However, if high oil prices persist for longer, inflationary pressures will further spread to the consumer end."
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