Higher fuel prices complicate an otherwise resilient economy

Trend watch

Rail traffic had an outsized 7.2% drop last week, though it was likely the Labor Day holiday impact. Also, air passenger counts are seasonally weak, staying in the low-16 million range per week. Looking ahead, air traffic should begin climbing in the coming week based on historical patterns. We’d expect an additional 750,000 to 1.1 million passengers as business travel ramps back up, pushing the weekly counts around 17.5 million by month end.

That should also boost hotel occupancy, which continues to slide from the summer peak. It slipped to 62.3 last week, which included Labor Day; that’s the weakest reading since early April.

We’re keeping a keen eye on gasoline and diesel prices.

Our take

The U.S. economy continues to navigate a difficult crosscurrent between resilient demand and renewed inflation pressures. Energy prices remain at the center of the story, with diesel prices surging to a record high above $6.45 per gallon while gasoline prices continue to climb toward $4.50 per gallon (both are nationwide averages). The latest increases are poised to keep consumers on edge, squeezing household budgets and raising concerns that elevated transportation and logistics costs could once again spill over into broader inflation.

That backdrop likely contributed to the Federal Reserve’s (Fed) decision to deliver its first rate hike since 2023. Like many central banks, the Fed was compelled to respond to oil-induced inflation. While the quarter-point increase itself was widely anticipated, policymakers made clear that additional tightening remains on the table. Given the resurgence in oil prices since August, we see limited room for inflation to abate; thus, we’re expecting another Fed rate hike in December 2026.

Despite those challenges, consumer spending has shown remarkable resilience. Retail sales climbed to a fresh all-time high in August. Perhaps more impressive, strength was broadly distributed across nearly every major retail category, suggesting consumers remain engaged across a wide spectrum of goods and services rather than concentrating purchases in only a few areas. However, we suspect that strength masks weakness for those with low-to-moderate incomes as gasoline accounts for a much larger portion of their budgets. Ultimately, while consumers are still spending, that dynamic won’t persist indefinitely as borrowing costs and fuel prices move higher.

Meanwhile, the production side of the economy continues to demonstrate underlying strength. Industrial production remains near a seven-year high, reflecting solid activity across much of the manufacturing sector. Although August saw weakness in transportation-related industries, including automotive, heavy truck, and aircraft manufacturing, the broader industrial backdrop remains constructive.

Housing inflation also remains an important piece of the economic puzzle. Annual rent growth continues to run below its pre-pandemic trend, providing some relief from the rapid increases seen in recent years. However, the monthly pace of rents has now returned to its historical trend, indicating that one of the key sources of disinflation may no longer be providing the same downward pressure on overall inflation readings that it did earlier in the year.

On the home sales side, the story isn’t any brighter as affordability remains a big challenge, constrained by both higher home prices and mortgage rates. And the latter won’t be helped by the Fed’s rate hike.

That said, the Fed rate hike alone doesn’t materially alter our near-term economic outlook. Market rates were already elevated, with the 10-year U.S. Treasury yield above 4% for the past two years and 30-year mortgage rates above 6% since mid-2022. Still, higher-for-longer interest rates and higher crude oil prices restrain economic growth.

Bottom line

Crude oil has forced a reset across the board, highlighting the critical role petrol plays in the global economy – from transportation fuel to industrial raw material for plastics, fertilizers, clothing, and medicines. Alas, the recent price resurgence has upended the inflation progress and boxed in the Fed.