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Two issues that have been rumbling on for months appear on the brink of change this week. We’ve seen news in the UK with a potential leadership challenge to the Prime Minister, and the US Iran ceasefire is once again under threat or is at best “on life support” in the words of President Trump.
Firstly, on UK politics, the discontent in the governing Labour party was clear this week in the aftermath of the English local elections. Prime Minister Keir Starmer said he would not walk away and would “prove the doubters wrong”, but the week saw several ministerial resignations including that of Health Secretary Wes Streeting, who is seen as one of the leading candidates to replace Starmer. Former Deputy Prime Minister Angela Rayner also looks set to take part in any contest. Yesterday the path for Andy Burnham, current Mayor of Manchester, to challenge Starmer became clear, with a Labour MP offering to step down to allow Burnham to stand in a by election to enter Parliament.
The continued uncertainty at the top of UK politics weighed on UK government bonds and sterling this week, though any change in leadership could still be some way off, depending on the timing of any contest.
Meanwhile, the US received Iran’s response to their proposals to bring an end to the war, which was described as “totally unacceptable” and “garbage” by President Trump. Trump has repeatedly said the war is over, even though he warned the ceasefire was now on “on massive life support” and again threatened to escalate attacks if Tehran does not agree to a peace deal. Brent Crude has climbed over the course of the week, and has not closed below $100/barrel since 21 April. There were also reports that Trump was considering restoring ‘Project Freedom’, the plan to free shipping from the Gulf using a protective naval umbrella. What is clear is with progress on a peace deal now apparently stalled, the issue of Hormuz and shipping (or the lack of it) will continue to put upwards pressure on commodity prices.
By the numbers
3.8% – the increase in US inflation (CPI) in April compared to last year, the fastest pace in three years, as energy prices drove up overall costs. CPI had already increased from 2.4% in February to 3.3% in March. The Core CPI figure for April was higher than expected at +2.8%. Gasoline prices were up 28.4% while airfares were up 20.7%.
6.0% – the increase in the US Producer Price Index (PPI) in April, higher than expected and the fastest annual pace since December 2022. Core PPI, which excludes food, energy and trade was up 4.4%, up from 3.7% in March and pointing to a broadening of inflationary pressures.
115,000 – the rise in US Non-Farm Payrolls in April, stronger than expected. The unemployment rate was unchanged at 4.3%. Given the inflationary pressures now emerging, the US labour market is likely to be less of a concern for the Federal Reserve than rising prices.
1 billion – the cumulative amount of oil that has been ‘lost’ from global supplies since the start of the Gulf conflict, according to Amin Nasser, Chief Executive of Saudi Aramco. Nasser warned that global stocks of gasoline and jet fuel could reach “critically low levels” ahead of the summer months if the Strait of Hormuz remains closed. Nasser noted that a cumulative 1 billion barrels of oil had been lost since the start of the conflict, with another 100 million lost every week the Strait remains closed. Inventories are the “only buffer that is available” but they have been “materially depleted”.
Market movers
If financial markets were not in such a good mood, then the US CPI and PPI data this week could have caused some turmoil. US inflation was trending higher before the Iran war caused a surge in energy prices but has now reached the highest level in three years; CPI has not been below the Federal Reserve’s 2% target for over five years, having never fully recovered from the 2021-2022 issues around the end of the pandemic and the Russia-Ukraine related energy price shock. Meanwhile, PPI data suggests we will see companies passing on price rises, or taking a hit to their margins, over the coming months.
President Trump described the rise in inflation as a “reasonable cost” of his efforts to deny Iran the ability to develop nuclear weapons. Trump told reporters, “The only thing that matters when I’m talking about Iran [is that] they can’t have a nuclear weapon. I don’t think about Americans’ financial situation, I don’t think about anybody, I think about one thing: we cannot let Iran have a nuclear weapon”.
Central banks can do very little about energy prices, so core inflation is what central banks will focus on for signs of inflation broadening. Ignoring fuel prices, inflation is still rising and other measures of inflation tell the same story. With oil futures suggesting oil will be at $90 at year end, the spike in energy prices is set to be prolonged, meaning a further broadening of inflation is more likely. Kevin Warsh, who was confirmed by the US Senate as the next Chair of the Federal Reserve is faced with rising inflation and a President who wants lower interest rates. But he also inherits a US economy in reasonable shape and in the midst of an AI revolution that could deliver a productivity windfall and is supporting strong equity market momentum.
The investment lens
Should the oil price be $60/barrel or $150+/barrel? This may seem like a strange question but there is a view that the current oil price looks ‘wrong’. There have been plenty of warnings about a looming supply crunch. At the start of the year, the consensus view for oil was that abundant supply would keep the oil price about $60/barrel this year. When the Gulf conflict broke out, oil soon climbed to $100/barrel but the consensus view was that crude oil would soon reach $150 or more if the Strait of Hormuz closure was ‘prolonged’. We are now 10 weeks into this conflict, and with no clear signs of a resolution.
JP Morgan research published earlier this week suggested commercial oil inventories in developed markets could “approach operational stress levels” by early June, and the “next phase of this shock may look less like a traditional crude spike and more like a refining and end user fuel crisis”. It would appear that the oil price could go much higher, or much lower, but $100 doesn’t look right.
Equity markets remain untroubled by the lack of resolution to the Hormuz issue, with the strong momentum in the tech sector after a stellar reporting season helping indices to new highs. The narrow leadership in markets is a concern, but the prevailing view is despite slow progress, we will see a resolution to this energy shock despite the US and Iran appearing for now far apart on sequencing and content of any peace deal.
