Summary
Highlights
The market experienced three significant repricing events: the US reimposing a naval blockade on Iranian vessels and a 20% transit levy on all cargo in the Strait of Hormuz, causing Brent crude to surge; Federal Reserve Governor Christopher Waller's warning about the Fed running out of patience with inflation and considering near-term rate hikes; and the June CPI report.
The June CPI report showed positive news, with overall CPI at 3.5% (down from 4.2%) and core CPI flat month-over-month at 2.6%. The energy index fell 5.7%, contributing significantly to this relief. However, this report reflects May and June data, before the newly imposed transit levy, suggesting the relief is based on an outdated economic reality.
The 20% transit levy on oil in the Strait of Hormuz will not primarily impact gas prices directly but rather upstream at refineries. This will embed higher costs into the manufacturing sector, affecting diesel, jet fuel, and plastic inputs, thus appearing first in core goods inflation, which the Fed previously considered manageable. This levy adds approximately $16 to each barrel, a 16-fold increase over previous tolls.
Five countries (Iraq, Kuwait, Qatar, Bahrain, and Iran) have no alternative shipping routes for their oil, and while Saudi Arabia and the UAE have some bypass infrastructure, around 14 million barrels per day would still have no alternative if the Strait were closed. Despite no legal basis for these tolls, Iran's foreign minister indicated willingness to negotiate a 10% levy, suggesting an ongoing negotiation for who profits from global energy transit.
PCE inflation was at 4.1% and core PCE at 3.4% in May, nearly double the Fed's target. Governor Waller acknowledged that inflation is no longer solely driven by energy and tariffs; core goods and services are rising independently. The structural 20% increase in energy input costs will elevate the non-energy cost base in an already overheated economy, leading to higher August and September CPI reports.
Waller, a known 'dove', signaled a conditional pivot, indicating that a 'hot' June CPI would necessitate tightening. While June CPI was 'cool,' the condition was for the *next* data print, which will reflect July's levy impact. The Fed's updated dot plot shows nine of 18 members projecting at least one rate hike by year-end, and the committee removed forward guidance, making every data print a potential policy trigger.
The market's initial celebration of the June CPI relief is misplaced. The structural cost shock from the Hormuz levy entering core goods inflation will force the Fed to act on data it cannot dismiss as transitory. This will impact those positioned for rate cuts, leading to higher mortgage rates and credit card costs. The current CPI report is the 'last clean look in the rearview mirror,' with significant new costs looming, promising a 'bumpy ride.'