MW The two reasons higher oil prices may not trigger the inflationary spike that investors fear
By Jamie Chisholm
The economy is better suited to absorb higher energy costs, says Jim Paulsen
Investors worry that surging oil prices will boost inflation.
Fears about the economic damage caused by surging oil prices saw the S&P 500 finish Thursday's session at its lowest level since the start of September.
As energy costs have risen, bond prices have fallen, pushing benchmark 10-year Treasury yields to their highest since late July, as investors reason inflationary pressures now mean the Federal Reserve might have to hike interest rates later this year.
But Wall Street veteran Jim Paulsen says two current disinflationary forces "may be underappreciated and could surprisingly moderate the ultimate impact higher oil prices may have on overall inflation."
Writing in his Paulsen Perspectives blog on Thursday, he says the first issue relates to oil-based inflation cycles. Paulsen presents eight previous noticeable U.S. inflation cycles during the last 40 years when rising oil prices played a role in what he calls "the inflationary thrust."
He observes that, importantly, the latest jump in WTI oil prices (CL.1) represents the smallest percentage increase in crude costs of any of the previous eight cycles highlighted.
Source: Paulsen Perspectives
"My point is the contemporary oil price spike is quite small compared to any during the past 40 years which resulted in any meaningful rise in inflation," says Paulsen.
And perhaps more importantly, he adds, the overall pace of U.S. real economic growth is far weaker today compared to any oil-price cycle during the last four decades.
For example, in cycle 1, real economic growth was between 3% to 6%, whereas during the last four quarters, real U.S. final sales growth was 2.4%, and U.S. job creation was zero.
"During the contemporary period, not only is the size of the oil price shock thus far relatively modest compared to those in the past, the pace of real economic growth is also far slower and consequently much less inflationary," says Paulsen.
Paulsen's second disinflationary trend relates to productivity, which has driven GDP growth.
Source: Paulsen Perspectives
Productivity-driven economic growth is the most disinflationary type of economic activity, he says.
Paulsen accepts that it's possible the war with Iran may be prolonged and oil prices shoot even higher. Still, the disinflationary factors noted suggest "the inflationary fallout from the contemporary oil crisis may prove far less debilitating than widely feared."
"Perhaps this is why, despite WTI oil prices rising by about 60% from their low this year, the 10-year U.S. Treasury yield has only increased by 20 basis points since year-end," he says.
The markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are slightly lower as benchmark Treasury yields BX:TMUBMUSD10Y rise. The dollar index DXY is up and gold futures (GC00) are trading around $4,426 an ounce.
Key asset performance Last 5d 1m YTD 1y S&P 500 6477.16 -1.96% -6.25% -5.38% 13.77% Nasdaq Composite 21,408.08 -3.09% -6.43% -7.89% 20.24% 10-year Treasury 4.461 7.40 50.90 28.90 22.20 Gold 4427 -1.45% -16.42% 2.19% 41.99% Oil 96.03 -2.10% 42.71% 67.27% 39.09% Data: MarketWatch. Treasury yields change expressed in basis points
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The buzz
Oil prices remain remain near recent highs, with WTI crude (CL.1) above $100 a barrel, after U.S. President Donald Trump extended his deadline for bombing Iran's energy infrastructure by another 10 days.
The U.S. Senate passed legislation early Friday to fund most of the Department of Homeland Security, moving to end a standoff in Congress that had led to missed paychecks for airport security workers and long lines for travelers.
Cruise operator Carnival $(CCL)$ will deliver earnings before the opening bell.
In a break with tradition, Donald Trump's signature will appear on U.S. bank notes, according to reports.
U.S. economic data due Friday include the final reading of consumer sentiment for March, published at 10:00 a.m. Eastern.
Fed officials making comments include Philadelphia Fed President Anna Paulson talking at 10:30 a.m. and Richmond Fed President Tom Barkin speaking at 11:00 a.m.
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The chart
Given the belief among some observers that prediction markets tend to reflect quite a lot of inside information, it's rather concerning that bettors don't see a quick end to the conflict between Iran and the U.S.-Israel. The chart produced by Goldman Sachs late Thursday, shows the Polymarket contracts for various dates the war may stop. The commodities research team at Goldman, led by Yulia Zhestkova Grigsby, notes that the implied probability of the war ending by mid-May stands at only 54%. (Polymarket has a business partnership with Dow Jones, the publisher of MarketWatch.)
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