Oil and Inflation

The US inflation rate started increasing in early 2021. At first, the official response from the Fed and the US Treasury was that the spike in inflation would be a temporary phenomenon caused by supply chain issues. As the months progressed it became clear that this was not the case, and the high rate of inflation persisted and continue to move higher. Here is the reported monthly CPI growth rate by month for 2021 and 2022:

The inflation rate grew throughout 2021 and peaked in June 2022. There has been an ongoing reduction in the inflation rate since then. The price of oil has been discussed as a main driver of this increase in inflation. Plotting the CPI year over year change and price per barrel of oil together as a line chart shows visually that they have indeed moved in conjunction with each other:

Finally, plotting the two sets of data as a regression reveals that the relationship is indeed highly correlated. The chart below displays the price per barrel for crude oil by month on the X-axis and the corresponding inflation rate for the same month on the Y-axis.

The best fit regression line is not linear but logarithmic. We can see that the effect (slope of the regression line) of oil prices on the inflation rate is most extreme at lower price levels and wanes at higher prices. While oil does appear to be a significant driver of inflation, its effect is limited on the high side. Predicting whether the inflation rate will continue to decline or reverse course is a major concern for the stock market headed into 2023. Considering the price of oil as a major driver of inflation provides insight into what to expect as 2023 progresses. As of the publication date of this post 1/29/2023, the price of oil sits at $79.68 per barrel. This would equate to an inflation rate of just under 6%, a further reduction from the 6.5% rate in December 2022.