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Markets continue await US inflation fall

US inflation data showed another jump. Markets can only resume a bullish trend when it is clear inflation has peaked in the US and when it is possible to see an end to rate rises.

| 5 min read

Last week's further rise in US inflation knocked markets again. The new headline number of 8.6% edged above the March high of 8.5% - and reminded investors that the price rises are proving tough to control.

Energy and food were, as usual, at the forefront – but so were airline fares and shelter. For the consumer, the advancing prices of petrol at the pumps is the outward sign that inflation is rampant. They make inflation President Biden's main preoccupation, as the US is wedded to relatively-cheap gas or motor fuel. We have been warning of more turbulence until we can see the pathway down to lower inflation and until the Fed thinks it can abate its hawkishness. These figures temporarily reinforce the need for the Fed to act tough as well as talk tough.

Meanwhile, Russia announced the return of interest rates to the 9.5% level that prevailed before the invasion of Ukraine. The ruble, which was badly hit by the opening of hostilities falling away from around 70 rubles to the dollar to nearly 140, has strengthened again. The Russian imposition of strict capital controls and insistence on ruble payments for its oil has delivered a very strong currency, now at 57 to the dollar. There is a view that, despite increasingly-tough sanctions, Russia is making a lot of money out of the much higher oil price her brutal attack on Ukraine has generated. It is clear from these moves that Russia is still selling a lot of oil and oil products.

Oil still vital in energy mix

We have argued for some time that this decade is still going to be mainly powered and heated by fossil fuels. The pace of transition to electricity from carbon-based fuels, and the pace of switching electricity generation from coal and gas to renewables, is such that we are likely to be needing more gas and still wanting 100 million barrels a day of oil for the next few years at least.

Russia was an important part of that equation, supplying more than 10% of the world's oil and a large proportion of Europe's gas, at around 40% of the total. It is true that, for now, the European Union has decided to rely on continuing gas and oil flows from Russia, whilst working to eliminate all non-pipeline oil by the end of this year and to reduce the gas gradually. Russia supplies up to 1.4 million barrels of oil a day by the Druzhba pipeline. Russia is also an important supplier of oil products, amounting to around 2.85 million barrels a day before the war.

Oil prices are up 60% this year rather than a larger amount which they would be if significant percentages of Russian oil output had stopped.

Opec thinks Russian oil output fell by 9.6% in April and may fall further for the year as a whole. It is difficult to know, as there are plenty of stories of oil being exported by ship from Russia without the usual documentation or visibility of cargo.

There are strong rumours that this oil can be switched to another ship at sea to disguise the origins of oil and allow it to circulate in countries that have imposed sanctions or can go on an illegal journey without the usual transparency. There is also evidence of Russia selling more to countries such as China and India that do not impose restrictions, but like a bargain. As a result, oil prices are up 60% this year rather than a larger amount than they would be if significant percentages of Russian oil output had stopped.

The west faces this dilemma

Inadequate sanctions and a lack of enforcement mean there is no effective blockade on Russian oil. Russia is enjoying a bonanza on the oil it manages to sell and transport – thanks to the high prices now charged even at a discount to market price. Should more countries join the ban on Russian oil – and help enforce it – the world oil price would shoot up further, increasing the likelihood of a recession.

Markets are assuming there will still be substantial supplies of Russian oil to those who will buy it to avoid a further crunch over oil supply. As western sanctions increasingly bite, more shipped oil will need to be diverted to vessels not registered in European or American jurisdictions. So far, Cypriot, Maltese and Greek flagged-and-owned ships have done well out of the diversion of oil from Russian vessels.

Markets can only resume a bullish trend when it is clear inflation has peaked in the US and when it is possible to see an end to rate rises. The latest inflation news prolongs the worries. The ten-year US bond yield moved up to 3.167%, proving 3% is no barrier. In sympathy, and facing its own inflation problems, the German ten-year bund hit 1.5% and the Italian a worrying 3.77%. Inflation should be falling in the months ahead but, in the meantime, central banks are having to opt for tighter money, to restore some of the damage done by being too loose for too long.

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Markets continue await US inflation fall

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