Crude Calculations: Oil Is Making the Fed’s Job Harder

Estimated reading time: 3 minutes

100 Reasons to Care

The Federal Reserve’s balancing act is becoming more tenuous – and inflation could be the culprit once again.

The average gas price in the U.S. was $3.88 last week, up 25% from the beginning of 2023, and bringing inflation up with it. Energy costs are a huge component of inflation. Oil prices are on the rise, driven by limited supply following production cuts. On Monday, the U.S. oil benchmark sat just below $90 a barrel. As prices climb towards the $100-per-barrel mark, there’s growing concern among investors that the Fed’s plans to control inflation could be jeopardized. A quick reminder: The Fed has a dual mandate – keep inflation in check and unemployment low.

To date, energy costs haven’t been a central focus of the central bank’s interest rate policy. But, as crude prices rise, Fed Chair Jerome Powell, who has already acknowledged the impact of energy prices on consumer sentiment, may be forced to say more.

Fuel to the Fire

Powell has repeatedly emphasized the Fed’s focus on core inflation, which excludes food and energy prices, when evaluating inflation trends. That’s because energy prices are volatile and may therefore not be as reliable an indicator of the broader inflationary pressures affecting the economy.

However, the climbing cost of oil risks tipping the U.S. economy away from the Fed’s intended target: a soft landing, characterized by getting the pandemic-era decades-high inflation under control without pushing the economy into a recession.

But historically speaking, surging oil prices were a precursor to economic downturns in the mid-1970s, early 1980s, and early 1990s.

On the flipside, it’s important to consider the American economic landscape has evolved since those tumultuous times. Fuel efficiency helped with that, as lower inflation-adjusted gas prices have made U.S. businesses and consumers less susceptible to oil price shocks than they were decades ago.

Crude Awakening

Although inflation has cooled from last year’s record highs, American consumers are feeling a renewed pinch from the rising price of oil. Spiking commuting costs, rising airfares, and costlier raw materials for manufacturers are just a few of the ripple effects.

The Federal Reserve will have to reckon with that when evaluating its efforts to manage inflationary pressures and making future policy decisions.

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