Persistent inflation weighs on the market as energy prices continue to rise

Persistent inflation and hedging implications

Consumer prices rose 0.4% in September, with the year-over-year gain at 5.4%. Overall, prices rose despite some recent areas of high gains seeing month-over-month decreases, as used car prices fell 0.7% and airline fares fell 6.4%. Supply constraints, labor shortages, and supply chain disruptions continue to push overall prices higher. Energy prices rose 24.8% year-over-year as all items less food and energy rose 4.0% over the last 12 months.

If inflation continues to show signs of persistence, the market will likely face higher yields, leading corporates to consider whether now is the time to lock in the current rate environment with interest rate hedges. As inflation persists, the market continues to weigh whether the inflation we’re seeing is transitory.

(Related insight: Read "Managing interest rate risk on future debt issuances")

Treasury rates and Fed tapering

Treasury yields fell throughout the week before recovering Friday after stronger than expected retail sales. The 10-year treasury started last Monday above 1.6%, rising as high as 1.65% before bottoming at 1.5% on Thursday. Retail sales data on Friday showed an increase in consumer spending of 0.7%, despite market expectations of a 0.2% decline. Slower consumer spending was expected as enhanced government benefits ended, but declining COVID cases allowed spending to accelerate. FOMC minutes from their September meeting showed consensus around beginning to taper bond purchases by the end-of-year. The minutes showed some dispersion around when there would be a need to raise rates, with several noting that “economic conditions are likely to justify keeping the rate at or near its lower bound over the next couple of years."

Saudi Arabia continues to resist calls for higher supply

Energy prices surged this week, most notably at the gas pump. WTI rose above $80 per barrel on Friday morning as strong demand continues amidst supply constraints. Saudi Arabia continued to dismiss calls for faster increases in oil output. The current plan calls for an increase of 400k barrels per day in November before another increase in the following months. U.S. oil supply rose slightly to 11.4 million barrels per day. However, that slight increase did little to curb rising prices.

High prices in other energy sources are also driving higher oil prices. Natural gas, coal, and renewable energies such as wind are in low supply, leading oil to backfill some of that demand. The International Energy Agency estimates that oil demand could rise by over half a million barrels per day in the coming months as heavy industries switch to oil.

Washington agrees to short-term debt solution

Congress approved a short-term increase to the debt ceiling last week, avoiding a potential default on U.S. debt. The Treasury Department had indicated they would no longer have the funds to fulfill their debt obligations if an agreement was not reached. The agreement raises the borrowing limit to $28.9 trillion, giving a two-month reprieve to the deadline for debt default.