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Cheaper oil could cool overall inflation and relieve pressure on consumers.
Oil prices continue to fall, and this could pose a new problem for investors and the Fed, warns Yahoo Finance.
Cheaper oil could cool overall inflation and relieve pressure on consumers. But it could also inject additional money into the economy—in a situation where it is already more overheated than the Fed would like.
This is precisely the shift that Apollo Chief Economist Torsten Slok points to.
"The narrative in the markets is shifting from 'low oil prices mean low inflation' to 'low oil prices mean rising demand in an already overheated economy, and therefore higher inflation,'" Slok wrote in a recent note. Brent crude and the yield on 2-year US Treasuries have been moving in sync for months. When oil rose, short-term yields rose. When oil fell, yields followed suit.
After the April CPI report, oil retreated to levels seen just before the latest spike due to Iran: both Brent and WTI fell below $70. But the yield on 2-year Treasuries didn't follow oil's decline.
But under the old inflation scenario, things worked differently.
High oil prices can raise the cost of consumer goods, increasing the costs of transportation, delivery, and production. They also leave consumers with less money for other expenses. When the oil shock passes, inflationary pressures usually subside along with it. But this time, the economy may not be cooled enough to solve the problem.
Lower oil prices could reduce the most noticeable inflationary pressures, especially at the pump. But they could also boost spending, travel, freight, and business margins at a time when the Fed is not interested in demand growth.
Slock's conclusion is stark.
"The market narrative now suggests that the opening of the Strait of Hormuz will further overheat the economy, forcing the Fed to raise rates soon," he wrote.