Oil prices climb another step, putting pressure on inflation’s “last mile”

Key takeaway: Driven by the ongoing escalation of geopolitical tensions in the Middle East, Brent crude has risen more than 15% within a month, returning to $88-89 per barrel and hitting a six-week high. However, this round of price increase is mainly a “risk premium” rather than a genuine supply-demand shortfall. In July-August, the year-over-year U.S. CPI is likely to rebound technically; the pace of disinflation will slow, but it does not yet constitute an out-of-control risk.

[Background] The U.S.-Iran conflict continues to intensify: The U.S. military has carried out strikes on Iranian targets for 12 consecutive days. The Houthis for the first time directly attacked Saudi oil tankers in the Red Sea. The Black Sea pipeline terminal facilities were also targeted. Market concerns about navigation security through the Strait of Hormuz (about 20% of global crude oil trading routes) have been mounting.

[Data and logic] 1) Oil prices: Brent crude rose from about $75.9 per barrel on July 10 to the $88-89 range on July 21-22. The month-on-month increase exceeded 15%, the highest in six weeks; WTI over the same period climbed from $71.6 to $82-83.

2. Base-effect switching in inflation: June U.S. CPI year-over-year was 3.5% (prior value 4.2%); core CPI year-over-year was 2.6% (prior value 2.9%); and on a month-over-month basis it fell 0.42%—about half of the decline came from the energy sub-item, which contributed a month-over-month drop of -5.7%. In other words, June’s “cooling inflation” largely reflects the lagged effect of the June oil price decline.

3. But the current supply-demand picture does not support a persistent shortfall: EIA data shows U.S. crude inventories unexpectedly increased by 1.4 million barrels last week, in contrast to the market expectation of inventory drawdowns. This indicates that this rally is priced more around geopolitical risk than a real supply disruption.

[Impact]

The energy disinflation tailwind seen in June is likely to reverse in July. There is a higher probability that the July-August CPI year-over-year released in August-September will rebound, but it is unlikely to return to May’s 4.2% peak;

The Fed’s policy rate path faces recalibration: The probability the market assigns to a September rate hike is still above 60%. If an oil-price-driven inflation rebound strengthens hawkish expectations, the time window for keeping rates at high levels could be extended passively;

In China, the refined oil pricing window (July 31 at 24:00) will most likely follow suit with an upward adjustment, which will create some input-type pressure on CPI/PPI. However, because domestic pricing is mainly determined within China, the transmission magnitude is relatively limited.

[Outlook] The baseline scenario remains “oil prices bounce around but don’t run out of control”—geopolitical risk premia exist objectively, but as long as there is no material disruption of navigation through the Strait of Hormuz and OPEC+ still has buffering capacity via remaining spare production, oil prices are likely to stay in a high-level range-bound pattern rather than a trend into a runaway upswing. The real turning point lies in whether the situation in the Strait of Hormuz escalates from a “threat” to a “substantive blockade,” which will determine whether the repair in inflation expectations can continue.

Risk warning: The uncertainty behind this round of pricing mainly comes from geopolitics rather than traditional supply-demand models, and price volatility could be significantly higher than the range estimated from fundamentals.

Recommendations: Track high-frequency indicators such as EIA weekly inventories, OPEC+ statements on remaining spare capacity, and shipping insurance premiums for the Strait of Hormuz to avoid simply extrapolating recent upside in a linear way.

DYOR