Commerzbank economists expect higher oil prices linked to the Iran War to lift US inflation. They forecast March CPI at 0.9% month-on-month and 3.3% year-on-year, up from 2.4% year-on-year in February, with core CPI at 0.3% month-on-month and 2.7% year-on-year.
They report an energy price shock since early March, with petrol, seasonally adjusted, up about 20% from February. They expect petrol to be the main driver of the March rise in overall prices.
Inflation Outlook Shifts Higher
They project the CPI downtrend to end and, under a scenario where the war lasts until the end of May, see inflation rising to nearly 4% in the coming months. They also state that CPI may understate inflation risks.
They note that before the energy shock, PCE inflation was 2.8% on the headline measure and 3.1% on the core measure. They add that inflation could stay above 2% for longer.
The recent oil shock from the war in Iran is set to end the downward trend in inflation. Energy Information Administration data shows WTI crude surged past $110 a barrel in late March, a sharp rise from February levels. This mirrors the price pressures we saw back in 2022, suggesting the fight against inflation is far from over.
We see the market rapidly pricing out any Federal Reserve rate cuts that were anticipated for this summer. Looking at CME FedWatch Tool data, the probability of a June rate cut has collapsed from over 50% to nearly zero in just a few weeks. This suggests positioning for higher yields by shorting Treasury futures or buying puts on bond ETFs could be a prudent strategy.
Positioning For Volatility And Higher Rates
Traders should prepare for a significant rise in market volatility as uncertainty around the Fed’s path and the conflict grows. The CBOE Volatility Index (VIX) has already climbed above 20, breaking its recent downtrend as of late March. Buying VIX call options or futures could provide a hedge against broader market declines driven by these inflation fears.
Higher inflation and interest rate expectations present a headwind for equities, especially technology and growth sectors. Therefore, purchasing protective puts on indices like the Nasdaq 100 might be considered for the coming weeks. Conversely, we anticipate continued strength in the energy sector, making call options on energy-focused ETFs an attractive way to play the direct impact of the oil shock.
A more aggressive Fed policy will likely strengthen the US dollar against other major currencies. Derivative traders could look at call options on the U.S. Dollar Index (DXY) to capitalize on this expected monetary policy divergence. Similarly, maintaining long positions in crude oil futures seems logical until the geopolitical situation shows clear signs of de-escalation.
