Lead

Cleveland Fed officials warn that U.S. inflation could climb to 4% as energy prices surge. The closure of the Strait of Hormuz is putting strong upward pressure on energy prices, from gasoline to diesel to jet fuel, that 4% U.S. inflation is rapidly coming into view.

Context

Headline annual PCE and CPI inflation rates have been above the Fed's 2% target every single month for five years and counting. So has core, stripping out more volatile food and energy costs. Figures last week showed that the annual change in the PCE price index – the Federal Reserve's preferred measure of inflation – hit 3.5% in March, the highest in nearly three years. The 0.7 percentage point jump from the month before was the biggest in five years.

Core PCE inflation, which the Fed pays equally close attention to, rose more slowly to 3.2%. But the longer energy prices remain elevated, the more likely they will eventually bleed into core inflation. On that score, policymakers have reason to be worried.

Key Data

The Cleveland Fed's real-time "Inflation Nowcasting" model projects that annual core PCE is currently running at 3.7% with headline PCE tracking at 5.4% and headline CPI at an eye-popping 6.1%. The red flags are suddenly a much deeper shade of scarlet.

Citing the relentless rise in gasoline prices, UBS economist Alan Detmeister reckons headline CPI inflation for May will come in at 4.3% – a rise of almost two full percentage points from 2.4% in February, before the Iran war started, and one of the largest three-month changes in headline CPI in decades.

Detmeister estimates that three-month annualized headline CPI inflation will reach 8.51% in May, which would be the fifth-largest reading since 1982 excluding the 2021-2022 pandemic years.

"Given the jump in daily gasoline prices in recent days, I think the risks to our headline CPI forecast for May are to the upside," he says.

The average price of gasoline at the pump is nudging $4.45 a gallon, up nearly 50% since the start of the war, according to the American Automobile Association. Analysts say that's the biggest increase in at least 30 years. And jet fuel is up more than 90% since the war started, with fuel oil jumping by more than 70%.

Quotes

Bob Elliott, CEO and CIO at Unlimited, reckons most major developed economies will soon experience 4% headline inflation if persistent $100-a-barrel oil flows through to broader prices.

"3% is already the new 2%," Elliott says. "When you come into an inflation shock with inflation already elevated, the it's transitory are much lower."

That's probably good advice. If Warsh learns one thing from outgoing chair Jerome Powell, it will be to avoid using the dreaded T-word.

The opinions expressed here are those of Jamie McGeever, a columnist for Reuters.

By Jamie McGeever; Editing by Marguerita Choy