The core (ex-food & energy) PCE price index is ‘nowcast’ to have risen by an annualised 3.31% in Q1. If the Fed cuts three times this year, against this backdrop, long-dated Treasury yields will jump. Gasoline prices have risen 13.1% YTD, creating a further headache for the Fed, and for the Biden administration. The Fed’s own Financial Conditions Impulse on Growth (FCI-G) index, introduced in June 2023, shows that financial conditions have become loose again.
The Fed may end up cutting once or twice this year. But taking a step back, the bigger picture remains the same: the 10-year Treasury term premium, which is hovering around zero, should be much higher given the fiscal risks, including from climate change. A renewal of Trump’s tax cuts, for example, would add roughly $5tr to the federal debt between 2026-35.
Record immigration in the US was a major (positive) supply shock last year. Climate change, however, is a negative supply shock in the short- to- medium term, due to both climate physical risks and the demands of the transition. The US is already coming up against capacity constraints from electrification and a booming economy that will put upward pressure on inflation. Cutting interest rates to support alternative energy companies, which are underperforming oil & gas, could be a double-edged sword. Stimulating demand will accelerate global warming.
Oil & gas executives struck a bullish tone at the annual CERAWeek conference in Houston last week. “Booming” construction of AI data centres, population increases and sweeping electrification require increases in all forms of energy, except coal. Power demand is surging, making clean energy targets harder to achieve, despite the growth of renewables.
