Dreams of Rate Cuts Dashed... Fed Trapped by the Strait of Hormuz [Weekend Money]

The recently released U.S. Consumer Price Index (CPI) for February showed a stable trend, aligning with market expectations. However, rising oil prices due to the ongoing war in the Middle East are emerging as a new variable that could impact price stability going forward.

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According to SangSangIn Securities on March 14, the U.S. CPI rose 2.4% year-on-year. Core inflation also matched expectations, increasing by 0.2% from the previous month and 2.5% from a year earlier. However, more volatile items such as food and energy showed an upward trend. Food prices increased by 0.4% from the previous month, and energy prices rose by 0.6% from the previous month. This upward pressure on prices is occurring even though the full impact of the Middle East war has not yet been reflected in energy prices.

The market is focusing on future inflation trends. This is because the effects of the Middle East conflict, which began at the end of February, and rising oil prices will be fully reflected in inflation figures after March. There are two main ways in which oil prices drive inflation. First, fuel prices are extremely influential, accounting for more than 90% of overall energy prices. Second, if fears spread that rising oil prices will continue to push inflation higher, this can have a ripple effect, causing price increases in other items not directly related to energy. The inflationary impact of oil prices is fundamentally a supply-side issue. Therefore, the Federal Reserve's conventional monetary policy-which aims to control inflation by reducing consumption-cannot fundamentally address these external cost increases.

If restrictions on transit through the Strait of Hormuz continue, there is potential for oil prices to climb even higher. Reflecting the U.S. Energy Information Administration (EIA)'s oil price forecast, the direct contribution of energy prices to inflation in March is estimated at 0.76 percentage points. Assuming the inflation rate for items excluding energy remains at its current level, the estimate for core inflation is expected to rise from 3.3% in March to 3.6% in May. There is a strong likelihood that average inflation rates above 3% will persist through the end of the year. In this case, it is likely that the Federal Reserve will keep rates on hold throughout the year.

Choi Yaechan, a researcher at SangSangIn Securities, stated, "If an early ceasefire and oil price stability are confirmed within March, there could be room for discussions about resuming rate cuts by the Federal Reserve in the second half of the year." However, he added, "Given that Iran is consolidating around the Revolutionary Guard and Mojtaba Khamenei, the possibility of an early end to the conflict is limited. Therefore, expectations regarding the path of Fed rate cuts should be viewed conservatively."

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