Elevated CPI Likely to Push Interest Rates Higher
Sept. 16, 2022
US CPI rose 8.3% in August from a year earlier, as the higher-than-expected inflation report diminished hopes the Fed could scale back the pace of rate policy tightening in the coming months. Inflation remains significantly above the Fed’s 2% target. The firmer-than expected print is an issue on two fronts. The first reflects the current state of inflation and its impact on people’s cost of living. The second facet is how it will influence the Federal Reserve’s behavior going forward. The market is now forecasting a terminal rate (peak of the benchmark interest rate) of 4.25%.
While both US stocks and bonds moved lower after these developments, the dollar maintained its broader strength. The strength of the US labor market, coupled with higher core prices, indicates that financial conditions need to tighten further, and this could translate into weaker oil demand going forward. Interestingly, the Fed Funds futures curve is currently indicating the market is pricing in interest rate easing beginning in 2023. This would result from a situation where the central bank raised borrowing costs more than necessary and created financial conditions that were too tight. In a rate cutting scenario for 2023, we would expect to see a weaker dollar which historically would be bullish for commodity demand.
At the same time, the world’s largest crude oil buyer, China, is facing strong headwinds due to the high inflation, COVID restrictions and a property sector crisis, that could invite additional fiscal stimulus by the end of 2022. In a forecasted scenario whereby Beijing provides fiscal stimulus, we would expect to see a strong rebound in oil demand for China in response to both a weaker dollar and domestic economic resurgence. We believe this would be bullish for total oil demand in the region, supporting an uptick in utilization rates at local refineries. In turn, this will incentivize additional VLCC tanker demand, with a bias towards long-haul movements, particularly should China limit the amount of Russian crude imports.
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