US diesel prices soared 83% during the year! Apollo's chief economist warns: Cost transmission may make core inflation more stubborn and difficult for the Federal Reserve to turn a blind eye

The Zhitong Finance App learned that Torsten Slok, chief economist at Apollo Global Management, warned that the threat of inflation brought about by the sharp rise in US diesel prices to historic highs may be more serious than the Federal Reserve is currently aware. Unlike the rise in gasoline prices, which is mainly directly reflected in energy expenditure, diesel costs are widely present in economic activities such as commodity transportation, retail supply chains, and data center construction, so they may be further transmitted to the core consumer price index (CPI). In an interview on Friday, Slok said: “When the price of diesel rises, it actually goes into categories other than energy projects in the CPI basket.”

This is particularly important for the current monetary policy of the Federal Reserve. The Federal Reserve has just implemented the first rate hike since 2023, and US inflation is still significantly above its 2% target. Since the core inflation index excludes energy prices, Slok believes that the Federal Reserve cannot simply view the sharp rise in diesel prices as a temporary energy shock, because higher transportation costs may eventually penetrate into the prices of core goods and services.

After the war between the US and Iran disrupted crude oil supply in the Persian Gulf, American consumers are already facing upward pressure on gasoline prices, but companies and transportation industries that rely on diesel have been hit even more severely. As of Thursday, the average price of diesel in the US has surged 83% this year to $6.50 per gallon; in contrast, gasoline prices rose 59% during the same period.

Slok pointed out that there is an important difference between the effects of diesel and gasoline on inflation. Diesel is widely used in commodity transportation. From retail supply chains to data center construction, it is inseparable from related logistics activities, and such demand has low price elasticity. Even if diesel prices rise sharply, it is difficult for companies to significantly reduce necessary transportation activities. This means that as fuel costs rise, transportation companies may have to pass on the increased costs to other companies and eventually to consumers.

Therefore, the impact of rising diesel prices will not be limited to the “energy” category in the CPI, but may spread through various channels such as logistics, commodity and service prices, causing core inflation to face longer-lasting upward pressure.

Slok believes that this kind of “secondary transmission” is an important difference between diesel price shocks and ordinary energy price fluctuations. If gasoline prices only rise in the short term, the Federal Reserve can usually pay more attention to core inflation trends after excluding energy and food. But if rising diesel prices drive up commodity transportation, construction, and business operating costs, which are eventually reflected in the prices of other goods and services, then the energy shock could turn into broader inflationary pressure.

Under these circumstances, it may be more difficult for the Federal Reserve to view the rise in energy prices as a one-time temporary shock. Currently, this issue is receiving particular attention because the Federal Reserve has just restarted raising interest rates. If the price of diesel continues to be high and further boosts core inflation, the pressure on the Federal Reserve to control prices is likely to increase.

At the same time, Slok believes that the boom in artificial intelligence investment is the most important reason why the US economy remains resilient in an environment of high interest rates. He estimated that AI-related economic activity currently contributes about 1 percentage point to the US GDP growth, which is equivalent to about half of the current overall economic growth.

This contribution comes not only from data center construction, but also the resulting energy demand, software expenses, and wealth effects brought about by the rise in the stock market.

In other words, the US economy is currently being affected by two forces simultaneously. On the one hand, the AI investment boom continues to support economic activity and demand; on the other hand, soaring energy costs such as diesel are increasing corporate operating and transportation costs, and may further spread to inflation.

This has also caused the Federal Reserve to face a more complex policy environment. Economic growth is still resilient, but inflationary pressure may become more stubborn as energy costs spread to core prices.

Slok also described a scenario that might prevent the Federal Reserve from further rate hikes. If the war between the US and Iran is resolved, the pressure on global energy supply will ease, and oil and diesel prices may fall back, thereby reducing inflationary pressure. In this case, the Federal Reserve may not need to raise interest rates further to curb prices.

However, Slok believes that easing the situation in the Middle East and driving energy prices back down may be the Fed's best hope to avoid further interest rate hikes right now, but there is still great uncertainty about whether this outcome will be achieved.