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The US markets have been focused on the fight against inflation for some time now, with every bit of news and every data release being seen through the lens of how it might impact the Fed’s decisions on interest rates. That is all very interesting, but it does tend to overlook the fact that short-term interest rates and other things within the control of the government and the central bank aren’t the only things that influence inflation. In fact, an argument can be made that they are not even the most important things.

It will be some time before economic historians agree on exactly what caused US inflation to spike to 9.1% in the summer of 2022, if they ever do, but right now it seems to be a combination of the effects of the pandemic on commodity prices, a government injection of cash into the economy to combat other effects of Covid, and ultra-low interest rates that were in place at the time. The flow of government money has eased, and interest rates are now at a level that is regarded as “restrictive,” but what of commodity prices?

As you might think, commodity prices have the closest and clearest relationship to inflation of any of its influences. If you look at a two year chart for inflation and for the Invesco DB Commodity tracking ETF (DBC), you can see that the fund’s highs in 2022 corresponded with the highs of the CPI print and the drop back has also been correlated.

There is, however, a “chicken and egg” question here. Are higher commodity prices a cause of inflation, or is inflation the cause of higher commodity prices? In a curious way, it is probably a bit of both. External forces can force commodity prices higher which causes inflation, but, at the same time, inflation elsewhere in the economy caused by things like fiscal and monetary policy disrupt the normal market pricing mechanisms and allow those prices to elevate and to stay elevated for a while.

Still, whether you take higher commodity prices as a sign or a cause of inflation, the climb during the last few weeks on the chart above for DBC is a bit worrying. That chart shows a little more volatility in day to day market pricing of the ETF than there is in the monthly CPI numbers shown on the inflation chart for obvious reasons, but after two consecutive months of misses on CPI and given how nervous traders are right now about resurgent inflation any upward trend in DBC is a cause for concern.

The main thing driving commodity prices higher is oil. With the development of alternative energy sources, the price of oil is not quite as influential on the world’s economies as it once was. However, between its use in plastics, transportation and still to a lesser extent, electricity generation, it influences the cost of production and distribution of almost everything produced in or imported into America. On that basis, the 1-Year chart for crude is a little worrying:

Crude has gained around 20% so far in 2024. So, what is driving oil higher this year and how far can it go?

The answer to the first question is not as simple as one thing. It is, as is usually the case, a combination of things that are moving oil’s price, but restricted supply is at the root of the move.

As the impact of Covid receded, the OPEC+ group decided not to allow prices to fall too far too fast. They instituted some output cuts among members that limited global supply and have since been extended. Then there is the geopolitical situation. Russia’s war in Ukraine and Israel’s retaliatory attack on Hamas have both resulted in supply disruptions, as have the actions of possible state sponsored pirates in major shipping channels.

That all adds up to tight supply, but that was basically balanced out by low expectations for economic growth, and therefore for oil demand, at least up until the last couple of months.

During that time, the notion of resilience in the US economy, and therefore in the global economy, has also gained credence. The data seems to be suggesting that a Fed Funds rate of 5.25% is not choking the life out of economic activity, and that growth of some sort is still possible as inflation falls. When that view meets the restricted demand that has been the norm in oil for some time, prices inevitably move higher. The problem, of course, is that if they continue to do so, the rate cuts that traders have been anticipating will be at least delayed.

As for how high oil can go, it looks as if it can and will keep moving higher, with a challenge of the psychologically important $100 level definitely on the cards.

From a technical perspective, there is no resistance until around $90, so that looks achievable before too long, and it would only take a 10% or so jump from there to get to $100. That is easily achievable with momentum as strong as it is currently.

Then from a fundamental angle, upward pressure will remain as long as supply remains restricted and demand expectations elevated, and there is no sign of either of those things changing in a hurry. Peace breaking out in either of the two major conflicts right now would be a wonderful thing, but one shouldn’t hold one’s breath in anticipation of it, and if US earnings season goes as expected, demand expectations will increase rather than decrease.

So, oil prices, and therefore probably commodity prices overall look set to continue higher for a while, which brings us back to the chicken and egg question. Is that going to be a cause of resurgent inflation, or is it a result of resurgent inflationary pressure? It is too early to give a definitive answer to that question, but in terms of the impact on the Fed and therefore interest rates, it may not matter.

Either way, if commodity prices keep climbing, the Fed’s hands will be tied, and “fewer and later,” not the once popular “sooner and greater” will be the applicable phrase when it comes to rate cuts this year.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.