Li Gang from CIWIS: Beware of US Reflation Risks Under Oil Price Shocks

Recently released U.S. February inflation data may seem uneventful on the surface, but financial markets are reacting with unusual sensitivity. The U.S. Bureau of Labor Statistics reported that the Consumer Price Index (CPI) increased by 2.4% year-over-year in February, and core CPI rose by 2.5% year-over-year, both in line with market expectations and previous values. Traditionally, such data suggests that inflation remains in a mild decline phase, and the Federal Reserve’s policy path should not change dramatically. However, after the data release, U.S. Treasury yields rose, the dollar index strengthened, while U.S. stocks and gold retreated. Implied rate hike expectations in interest rate futures cooled significantly, with the full-year rate cut forecast being re-priced to about once. This “calm data—market tension” divergence reveals the real focus of current macro financial markets: inflation has not truly ended, and new inflation pressures are re-emerging. Especially with Iran conflicts pushing up international oil prices, February CPI appears more like a brief calm before the storm. Understanding this macro narrative shift can be approached from three levels: re-pricing inflation expectations, structural changes in inflation, and energy shocks reshaping future inflation paths.

First, from the asset market reaction, the most noteworthy change is not the inflation data itself but the market’s re-pricing of future inflation trajectories. Over the past year, the core logic of global macro trading has been “inflation retreat—policy easing—liquidity improvement.” This narrative supported risk asset valuations and strengthened market confidence in the Fed’s rate cut cycle. But post-February data, market reactions indicate this logic is subtly shifting. Rate futures show the probability of a Fed rate cut in July has fallen below 50%, and the September cut probability is less than 80%. The full-year rate cut forecast has been compressed to about once. Meanwhile, yields on 2-year and 10-year U.S. Treasuries are rising in tandem, and the dollar index has rebounded toward 100. In other words, markets are gradually correcting overly optimistic policy expectations.

This re-pricing is not driven by a single data point but by rising uncertainty about future inflation paths. The February CPI data was collected before the escalation of Middle East tensions in late February, so it did not reflect the cost shocks from rising oil prices. Once markets realized this “time lag,” trading logic shifted quickly: current data reflects the past, while future inflation risks are the key to policy decisions. In essence, markets are transitioning from “rate cut trades” to “re-inflation trades.”

Second, regarding inflation structure, internal changes are occurring within the U.S. price system. Over the past two years, U.S. inflation has gradually declined, largely relying on two factors: a rapid drop in goods inflation during the pandemic, and cooling housing inflation. However, recent data shows goods inflation is rebounding. In February, core goods prices rose 0.1% month-over-month, a noticeable increase from previous levels. Breakdown by category, affected by trade policies and supply chain factors, shows prices for apparel, appliances, furniture, and other import-sensitive categories are rising. Meanwhile, software prices surged by 6.5% month-over-month amid the rapid development of AI industries, adding a new variable to recent inflation structure. This indicates that technological cycles are beginning to influence price dynamics anew.

More importantly, the rebound in goods inflation could amplify its impact on future inflation indicators. Compared to CPI, the Personal Consumption Expenditures (PCE) price index assigns a higher weight to goods, so a rebound in goods prices will more directly lift PCE inflation. According to Cleveland Fed estimates, the February PCE month-over-month growth could reach 0.3%, higher than previous levels. If this trend continues, market confidence in sustained inflation decline could be challenged. Housing inflation, however, remains slowly declining—February rent for primary residences increased only 0.1% month-over-month, the slowest since 2021; owner’s equivalent rent held steady at 0.2%. This trend aligns with earlier signals from real estate rent indices. The cooling in housing inflation provides an important buffer for overall inflation, but whether it can fully offset upward pressures from goods and energy remains to be seen.

Third, and most crucial in the coming months, is the impact of energy price shocks on inflation trajectories. With escalating tensions in the Middle East, risks to shipping through the Strait of Hormuz persist, and international oil prices have risen sharply. Historical experience shows energy prices not only directly push up energy components in CPI but also generate secondary effects through transportation and production costs. Estimates suggest that a 10% increase in oil prices could raise energy CPI by about 2.4% and lift overall CPI by approximately 0.15 percentage points. Considering cost pass-through and expectation effects, the total impact on inflation could approach 0.3 percentage points. While this may seem limited, in the context of inflation still above the Fed’s 2% target, such upward pressure could alter policy expectations. Notably, February CPI did not reflect this impact because data collection occurred before the Iran tensions escalated. This implies that actual inflation pressures may emerge over the next few months. The March and April inflation data will be key to observing whether energy shocks spread further. If oil prices remain high, the downward trend in inflation could be interrupted again.

In this context, the Fed’s policy space becomes more complex. On one hand, the U.S. labor market shows signs of cooling, with slowing hiring demand and a tightening labor market; on the other hand, inflation remains sticky, and energy shocks add new upside risks. Policymakers must balance growth risks against inflation risks. Therefore, it is likely that the Fed will maintain a wait-and-see stance through the first half of the year. The key turning point for policy could depend on clearer signals from oil prices and inflation data. In other words, U.S. monetary policy has entered a passive waiting phase.

Overall, while February’s CPI data met expectations, the macro picture it reveals is far from calm. Rising goods inflation, energy shocks, and market re-pricing are collectively changing the global macro narrative. In a sense, the inflation-downward cycle that dominated the past year is facing challenges, with new uncertainties stemming from geopolitical and supply shocks. For investors, the real risk is not just monthly data fluctuations but the potential for inflation to re-center higher. If oil prices stay elevated, the U.S. inflation path could become turbulent once again. At that point, markets may face a familiar reality: in an era of frequent geopolitical conflicts, inflation will not easily return to the low and stable levels of the past.

Author’s note: These are personal opinions and for reference only.