Your Bills Are About to Go Up — The Fed Can’t Stop It

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2:00Welcome to Prof G Markets. I'm Ed Elson. It is March 19th. Let's check in on yesterday's market vitals. The major indices fell as the Federal Reserve announced its interest rate decision. More on that in a moment. Treasury yields climbed. Meanwhile, Brent crude prices jumped after an airstrike on Iran hit one of the world's biggest gas fields. Okay, what else is happening? The Federal Reserve has decided to hold rates steady. That outcome was widely expected. Kalshi put the odds of a hold at 99%. In its statement, the Fed noted that the economic implications of war with Iran were, quote, uncertain.

2:42Meanwhile, recent inflation data has been discouraging. The producer price index rose 3.4 % year over year. That was its biggest annual gain in a year. and core PPI, which excludes food and energy, came in at 3.9%. Personal consumption expenditures told a similar story last week. Core inflation rose 0.4 % in January alone and 3.1 % year over year. And remember, these reports only offer a rear view mirror. What is ahead is looking even worse, at least for now. Since the US struck Iran on February 28th, the price of oil is up 40 % and gas prices have risen more than 30%. As price increases are also hitting other industries, such as agriculture, where the cost of fertilizer has risen 25%.

3:32So the bottom line is, our bills are probably going to go up even more. Here to discuss the inflation outlook for 2026, we're joined by another panel of experts today. We have Michael Gapin, Chief US Economist at Morgan Stanley, and also Robert Armstrong, financial commentator for the Financial Times and author of the Unhedged newsletter. Michael, Robert, thank you both very much for joining us. Michael, I'm going to start with you. We got the Fed decision. Rates remain where they are. Everyone expected that. Was there anything else we found out, anything that is perhaps unusual, interesting, or maybe changes the situation in any way?

4:15I wouldn't say that there was anything unusual because the standard playbook for the Federal Reserve in a situation of getting an oil price shock is to be predisposed to want to look through any increase in headline inflation. So I think what I heard a lot of, though, and you noted it, the repetition of uncertainty, uncertainty, uncertainty. Writing down a forecast at this point in time, very difficult. Powell said, take our forecast with a grain of salt. And he said, this is one of those moments where probably not submitting a forecast would have been easier than submitting one. And so I think, yes, the Fed is saying, OK, headline inflation will be rising.

4:59But that's only part of the story. This is another supply shock that puts upward pressure on both inflation and the unemployment rate. So that leaves our goals in tension. so to know what to do we probably need to see some more data and so i i think he gave what a a balanced view of the outlook could be higher inflation could be weaker labor markets and and then interjected a little uncertainty and caution and i think that's the appropriate response so i wouldn't say a lot new um but just the re-emphasis on uncertainty uh you know it tells you again it's The Fed would like to see progress on inflation, but now there's kind of another hurdle that it has to overcome this year.

5:44What about looking forward in terms of rate cuts, Robert? What did we learn, if anything, about what we're going to see in 2026 from the Fed?

5:56Robert Armstrong:I mean, if you look at the notorious dot plot, and I do want to take on board Michael's comment that this is the chair Powell and the Fed was obviously not very pleased at having to have give to give projections this time around, given that we've rolled the iron dice and there's so much war uncertainty. But if you do look at that dot plot, which shows the projections for appropriate rate policy this year, there was kind of a bit of compression. Now, nobody is looking for rates to be increased again this year. But the tail of people who think there should be several cuts pushed up as well. So the plot for 2026 kind of compressed.

6:44Robert Armstrong:And partly that's an expression of uncertainty. And partly it's saying we are stuck here with these, what Powell describes as modestly restrictive rates. And we're stuck between the two ends of our mandate. And what are we going to do? We're going to sit and wait until something happens. And I don't know what else in their position. I don't know that there's anything smarter to do than that. Well, I think for consumers and for observers, I mean, my intro there basically said it, which is inflation appears to be set to rise. And that's what we're all worried about. And so I guess the question was something that I was expecting was for them to say, yeah, this is something we're quite worried about, too.

7:29And it sounds like what we heard was we don't really want to say anything about it. we're going to acknowledge the elephant in the room, which is that Iran is happening, and that that's going to have an effect on oil prices, it's going to have an effect on gas prices. In fact, we're already seeing it. But even when you look at, you know, what the members of the FOMC predicted, 12 of them said, yeah, we're going to get at least a cut in 2026, which I guess to me, I'm kind of like, well, aren't prices set to rise quite dramatically. Michael, what do you make of the possibility that we could have quite rampant inflation now that the Iran war is kind of well underway?

8:11So you're right that there is already clear evidence that prices will go higher. We're seeing it in gasoline prices that are up 50 cents to a dollar per gallon nationwide. And oil and its byproducts, our inputs into things like fertilizer and diesel fuel and airline prices. So you will see it. And yes, we are already seeing it. The question from the point of view of the policymaker or the Fed is, well, how long will oil stay elevated? If there is a, let's call it fairly quick, you can be subjective about your definition of that. If there's some fairly quick resolution to this, and oil is back down to its$60 to$70 range where it was going into this, say, in May, it's hard to argue that the broad outlook for the United States has changed a lot.

9:06But it could be that oil prices stay elevated much longer than that, or even move higher from here. And so, yes, you could get a prolonged inflation shock, but the higher oil prices go, it also means demand is weaker and labor markets are likely to be weaker. So I think the Fed did acknowledge today and Powell acknowledged today and their forecast acknowledged inflation will be higher. But the uncertainty part of this as well, it depends on how long this geopolitical uncertainty in the Middle East lasts. And the Fed's no better at predicting that than I think anybody else. So I think that's the dilemma they're in.

9:44It seems like the future of our economy right now of inflation right now is basically entirely dependent on how long do we stay in Iran and how long until this situation is pretty much resolved. And I guess that's on the president. I mean, it's not clear to me how any of us have any sway over how this is resolved. But I mean, that's what we're talking about here, right? This all reverse engineers to like how long we lost in Iran.

10:19Robert Armstrong:I think the real problem for the policymaker, as Michael suggested, is that rate increases are a terrible tool for dealing with high energy prices. Right. Like if you're going to control high energy prices, you're going to have to do so much damage to demand with higher rates that you're going to wish you didn't do it in the first place. Right. That's why the Fed policymaker wants to look through this stuff. I would note, however, that in this meeting today, the long-running inflation dramas did come up. Namely, are we going to see the half a percentage point of inflation that we think is coming from good tariffs on goods?

11:03Robert Armstrong:Is that going to go away, as we all think? Chair Powell sure hopes so, and so did the rest of us. And it was interesting, when he was asked, the first question he was asked was, do we look through oil price inflation? And his answer was, the first thing I'm looking for is for tariff inflation to go away. And once we get that dealt with, I'll be able to worry about oil. And the second long running drama that got mentioned that I thought was interesting is he was talking, the chair was talking goods, inflation, goods, inflation, tariffs, tariffs, but he was pushed by one of the journalists who said, well, aren't services inflation when you take out housing aren't those kind of sticky at three percent now for quite a long time and he was kind of like yeah that's pretty frustrating too we wish that wasn't true so like there are it's not all it's not all it's a lot oil is is the headline now and it's a big story yeah but you know the way i look at it inflation's kind of at three right and it's going sideways yeah right and that was true before we started this maybe you know you could say it's 2.8 or 3.1 or whatever, a PPI report, whatever, but it's somewhere in there.

12:16Robert Armstrong:It's a point above, it's a point above where it should be and it's going sideways. And we don't really know why. I mean, Michael may know why. Well, Michael, I mean, when we look at the inflation that we already were dealing with, which was, you know, maybe moderating, but still pretty sticky and certainly nowhere near the 2 % target, add on top of it, what's happening to oil. What are your inflation expectations going forward. And for those who maybe haven't thought about the connection between oil prices and everything else, how could those prices trickle down through the rest of the economy?

12:55How could it show up on the bills of regular households across America? It was interesting today because obviously this is a meeting where the Fed released its updated projections. And we looked at them and we said, oh, that's interesting. Their forecasts now look a lot like ours. So I think, as Rob mentioned, it will be an outlook then where headline inflation is close to 3 % by the end of this year. And the Fed thinks core inflation, so if you exclude food and energy prices, could be somewhere around 2.7%. So some diminishment in core goods inflation, but not a whole lot. So the trajectory is there from the Fed's perspective.

13:40It's moving in the right direction still in their forecast, but it's a quite gentle downslope. So this is, you know, view that the oil price shock is another hurdle that the Fed will have to overcome in order to ease rates. And on the second part of your question, yes, oil moves directly from oil prices to gasoline prices in the U.S. It does that very quickly, usually within about two weeks. And so we see that. So what they will be worried about is what we call second-round effects, right? Because oil and energy is an input into the production process more broadly. For example, roughly 40 % of the cost of food when you go into the grocery store is related to transportation costs.

14:27Right. So you can get second-round effects on inflation. Now, history says you're not likely to because the higher oil prices go and the more you and I have to spend on gas, the less we have to spend somewhere else. So there's usually some demand destruction that prevents that second-round effect, but there's no guarantee. As Powell said, we're about five years of inflation running above 2%, and at least short-run inflation expectations have moved higher. So there's no guarantee we won't see second-round pass-through effects, but history says they should be limited. And as Rob said, the answer then is you kind of need more time to see what's happening.

15:09Robert Armstrong:I guess the other point I'd make there, Ed, is that there is this kind of question out there is like, how many times can you kind of punch the economy in the face before it becomes permanently grouchy about the future? and where you have things like, you know, longer term inflation expectations go up because you get these shocks, whether it's, you know, COVID and then it's tariffs and then it's this war. And it's like, you know, you're taking all these hits. And at some point you start to think maybe I'm in a kind of nasty inflationary world and my longer term expectations for inflation start to trickle up.

15:51Robert Armstrong:I should note that is not happening now. I was looking at five-year, five-year forward inflation break-evens this morning, which is like a kind of tricky mathematical way of getting an estimate of what inflation is going to be in the five years starting in five years, right? So you like subtract various bonds from one another. They haven't moved at all, right? No change since the start of the war. So the inflation the market anticipates is all in the short term. And that's a good sign so far. What I think would scare me to death and would certainly scare Chair Powell and the rest of his committee to death is if you see someone anchoring at the longer end of the curve, higher term, premium, whatever, that would be bad.

16:32Robert Armstrong:But so far, it's been amazingly stable out there, right? Like, you know, as he emphasized today, we're not seeing any sign of that, but that would be the bad thing to look for. It's so interesting because, I mean, what we're trying to do here is we're trying to predict the future. We're trying to predict the future of prices. And as we said, kind of at the top of the program, like that all relates to what happens in Iran, at least for now. That's what the whole question is all about, which means that these analysts and these investors have to try to put on their sort of military strategist hats and try to predict what on earth is going to happen in the Middle East, which seems to me to be a very difficult thing to do and certainly a very difficult thing for investors to do because we're not military experts.

17:17So I guess my question to you, Michael, over at Morgan Stanley, where that is the job as the economist of the firm and as the guy whose job it is to figure out what's going to happen, like, how do you think about these issues when they're so specific to geopolitics and to literally military strategy? Well, you're putting me on the spot on this one. I would say maybe a trite answer. I mean, you do your best, but you recognize that the error bands, as we would say as an economist lingo, the error bands around your forecasts are a lot wider. So let me give you an example. Right now, if you look at options on oil, they're what we call bimodal.

18:05There's kind of a mass of expectation saying oil's probably going to come back down to around$70 a barrel, and then there's a second mass at around$150. and this gets back to i think to your earlier point about a lot of the outlook then depends on how long we sit where we are right the longer the straight is closed you might see a shift to 150 if there's a resolution you can go back to 70 so the answer tends to be you need to write multiple scenarios of how the world could evolve and then place kind of subjective probabilities on those. So the usefulness of one modal, most likely baseline outlook diminished in this environment.

18:49And you have to be a little flexible and say, it could be this, it could be that. Let's sketch out how both of those scenarios work. So that's about the best you can do. Yes, which is, of course, unsatisfying for all of us, but that's what we have to deal with. It's where we are. This is the life we have chosen, as they said in the Godfather. Stay tuned for more of this panel after the break. And for even more markets insights, you can subscribe to my weekly newsletter, Simply Put, at simplyput.profgmedia.com.

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21:35We're back with our panel. When you think back, Michael, to our previous round of runaway inflation, when you think back to like post-COVID 2021 going into 2022 and the impact that that inflation had, At least that's what's in my mind right now. I mean, we're looking at a situation where we don't know what the inflation picture is going to be, but it's very uncertain. And it seems that a runaway situation is on the table because of what we're seeing, not just in America, but also in Europe, which is getting absolutely hammered, at least prices over there. In Asia, it all reminds me of that post-COVID era where everyone's inflation was going out of control.

22:17And then suddenly everyone had to figure out how to deal with it. Most decided, OK, we're just going to raise rates. We're going to tighten as much as we can. And then we did see a very significant drawdown, more than 20 percent decline in the S &P. And it was largely a function of this inflation problem that was stemming from supply chain issues because of COVID. I'm just reminded of what happened there when I look at what's happening right now. Is that the right thing to think about or is this just completely different? I'm going to push back on that and say I do think it is different. um the covet story was certainly obviously as everyone knows it was a global pandemic and supply chains globally were were constrained so you given the integration of the global economy um and the share that goods are in the average person's consumption basket it's over 10 percent up as high as maybe 20 percent now gasoline for example is is about two to three percent so the magnitudes of the shock here are are very different so i think the ultimate effect on inflation will be different and just from a historical perspective if someone were saying oh michael but what about the 70s that was more like a 400 increase in oil right so that you know that's kind of like oil going from 60 to 250, right?

23:43Okay. Then I'm, then I'm with you. It's much bigger problem. Um, it'll downstream into other things that your literal stagflation scenario. But I don't think, um, the oil shock we're seeing now is reminiscent of that. And last point, I'll turn it back to you or Rob for comments. We were at about$120 a barrel in, in 2022 when, when Russia invaded Ukraine. So we're, we've been in this territory for a while and it didn't entirely derail the U.S. economy. So yes, a push price is higher. I agree with that. But, you know, I think we're better at dealing with this than a global pandemic. Rob, what do you make of that?

24:21Robert Armstrong:Only things I can, I think that's exactly, Michael's got it exactly right as far as I can see. Only things I would add is, you know, back post-COVID, tight job market. Now we've got kind of a squishy one. And I wish it wasn't squishy, but that'll help on the inflation front. In theory, it should. And also back then, you know, we had the government putting dollars into people's pockets. Now we have the gas pump taking dollars out of people's pockets. Again, that should be a bit deflationary. So, but I think Michael has the picture, right? I mean, by the way,$200 oil is not a scenario we should completely dismiss.

24:57Robert Armstrong:I think it's over in one of the tales, but, uh, the, you know, again, we all become emergency experts on things. But, you know, in the last week, I've become more of an emergency expert on the kind of oil inventories. The longer the Strait of Hormuz stays closed, it's not like there's a linear increase in the price of oil. You know, global inventories start to get down, the well starts to dry, and you have a geometric increase in prices. So I'm not saying we're going to get$200 oil. I'm just saying I'm not laughing at the very suggestion. Right. Yeah,$200 a barrel is something that I think needs to be at least in people's models.

25:39You need to entertain the possibilities. And then the other word that I keep on hearing is stagflation, which is a word that comes up every now and then, but it's a very scary word. And it's now kind of a little bit more in vogue. uh rob is stagflation one what is stagflation and two is stagflation something that is genuinely or potentially on the horizon here uh well powell was asked about stagflation today and he said

26:11Robert Armstrong:stagflation is something that happens in the 1970s where you have a massive increase in an employment you have 10 unemployment and you have inflation at 10 or something and it's like you're really getting it from both sides, but you can get a micro stagflation, which is, you know, the, the fed being stuck. Inflation is too high for you to really stimulate, but, uh, the economy is slowing down. So you want to stimulate and what can you do? And, you know, to a certain degree by that more modest or small definition, definition of stagflation, it's already happening now you get the the economy is pulling in both directions and you know that can get worse and what's miserable about it is that it's not clear what the policy response is what do you do about it you know so uh we knock on wood you know yeah let's not do an experiment in that you know let's not i don't know if michael is i'm old enough to just barely remember the 70s stagflation and in particular its effect on the price of candy bars and the general mood around my house and uh it was bad it was really bad yeah michael what what do you think about that comparison i mean are we close or are we getting close to a stagflationary scenario here or is that far off i mean not as rob says not the literal definition of stagflation, which is falling output or negative GDP growth, rising unemployment and rising inflation.

27:48But this is, if you kind of think just about persistent inflation and sluggish growth, then yes, you could certainly be on the verge of that. What's helping the economy a lot right now, of course, is AI-related business spending and some productivity gains. So, I mean, you actually saw the Fed revise higher its growth forecast for 2026 today. I suspect it would have been even higher had oil prices not risen. But, I mean, I think it's obvious for the listener how a mini stagflation scenario would play out. If something like you mentioned,$150 or$200 a barrel, became a reality, then you're talking$5,$6 gasoline, right?