Oil Price Spike to Cause Stagnation

We now believe that the recent surge in oil prices will cause an uptick in inflation resulting in stagnation, so we are declaring victory on our StagDeflation call as all inflation readings this year have shown declining inflation with the critical shelter component recently continuing its slow deceleration dropping from .4 to .3 last month.  The decline is likely to continue as the BLS only updates the index every six months and it is further lagged by the practice of surveying renewing leases.  In fact, our PCE-R index, which utilizes market prices, is already at the Fed’s arbitrary 2% target and we project that even the reported PCE Core will decline to 2% by mid-next year as the higher shelter readings over the last year roll off.

The rapid rise in oil prices will impact both headline inflation and will bleed through to core as all companies use energy for both manufacturing and services. Oil prices are a critical predictor of inflation as the use of energy is ubiquitous unlike increases from tariffs which are by definition a one time increase that should be ignored for the purposes of setting monetary policy.  We also continue to forecast the US economy will decelerate into the 1-2% growth range as ultra-tight Fed policy weighs on the housing and construction industries.  We do not forecast a recession, which is the normal outcome of a Fed tightening cycle, as tech spending is booming which is offsetting the decline in the interest sensitive sectors.  We forecast that this slowing will force the Fed to cut twice this year as the slowing economy impacts the labor market.

We are bullish on both stocks and bonds with a 6,600  target on the S&P 500 Index for year end and a 3.75% target on the 10-year Treasury.