Is Inflation Spiraling? Oil, Tariffs & AI in the New Pricing Cycle

💡Key economic indicators suggesting building price pressures before the US-Iran conflict included the Producer Price Index (PPI) exceeding expectations for two consecutive months in January and February 2026, with YoY growth surpassing 3%. Additionally, the Prices subcomponent of the ISM Manufacturing Index surged to 70.5 in February and further climbed to 78.3 following the March escalation, marking its highest level since July 2022, indicating pre-existing supply-demand dynamics.

💡AI-driven demand contributes to rising prices for raw materials and electronic components by intensifying supply shortages, particularly for items like aluminum and copper used in server racks, thermal components, and cable connections. Computer and electronics-related components within the PPI have seen massive gains, with Electronic Components and Accessories experiencing a nearly 18% YoY growth rate due to cost pressures reflected in price adjustments. This indicates producers are passing cost increases to end consumers, as seen in the Computer Software and Accessories CPI component maintaining over 5% YoY growth.

💡AI expansion sustains manufacturing activity and capital equipment investments by spilling over into non-AI sectors, keeping overall manufacturing robust, as indicated by the MM Manufacturing Cycle Index's upward turn in the second half of last year. This renewed demand has led enterprises to increase investments, with the YoY growth rate for Private Capital Equipment within the PPI steadily rebounding from 2.7% in early 2025 to its current level of 4%. Furthermore, post-conflict inventory replenishment for defense and military resources will further support manufacturing momentum, exerting upward pressure on manufactured goods prices.

💡Runaway inflation is considered unlikely despite current price pressures because the impact of tariffs is expected to be a one-time price adjustment that diminishes over time, and the energy shock is anticipated to be short-term, contained within a single quarter. Additionally, "sticky" inflation, particularly shelter services like Rent of Primary Residence and Owners' Equivalent Rent, which account for over 40% of CPI, is expected to continue decelerating throughout 2026 due to increasing rental supply and a stagnant labor market, preventing a broad-based resurgence in core inflation.

💡The energy supply structure has significantly changed since the 1970s, making current oil price shocks less impactful. In the 1970s, OPEC crude oil production exceeded 50% of the global total, whereas today, the United States accounts for up to 20% of global production. This increased US production means that negative impacts of high oil prices on employment and economic activity are partially offset by increased profits for US oil companies and potential expansion in drilling activities, unlike the past.

💡The economy is less vulnerable to energy price shocks today compared to the 1970s due to advancements in technology and energy efficiency. Energy's share of overall consumption and GDP has steadily declined, with energy-related expenditures as a percentage of overall Personal Consumption Expenditures (PCE) dropping from around 40% in the 1970s to 24% today. Furthermore, the energy intensity of GDP has decreased by nearly 40% since 2000, making it extremely difficult for soaring oil prices to replicate the scale of inflation and economic shocks seen in the 1970s.

💡AI and manufacturing-driven price hikes lead to industry structural optimization by incentivizing manufacturers to accelerate their transition to next-generation products through direct and indirect pathways. Direct beneficiaries see expanding demand for new products, triggering price hikes and investments in production capacity, while indirect beneficiaries experience capacity crowding-out for older products, causing shortages and price increases. This process ultimately leads to generational turnover, boosting overall productivity and optimizing industry structure.

💡Productivity improvements driven by AI can help suppress medium-to-long-term inflationary pressures by incentivizing manufacturers to accelerate their transition to next-generation products, leading to industry structural optimization and an expansion of aggregate supply. This echoes the 1990s phenomenon where a productivity boom, driven by the internet, kept inflation near the 2% target despite a tight labor market. The accelerating productivity following ChatGPT's emergence suggests a similar pathway, where increased output and efficiency can offset price increases over time.

💡In April, crucial market developments to observe for assessing the impact of the US-Iran conflict include the release of US March CPI data on April 10, which will begin to reflect the material impact of the conflict. This period will also involve the market repeatedly testing the bottom, with reactions to negative data serving as a key indicator. The ongoing US-Iran situation's phased progress and potential outcomes ahead of the Trump-Xi summit will also be critical.

💡Factors that could lead the market to an upward trend after data tests the bottom include a gradual dulling of the market's reaction to negative data, Kevin Warsh taking over as Fed Chair after mid-May, and the US-Iran situation achieving phased progress ahead of the Trump-Xi summit. These developments, combined with an anchoring by productivity improvements, could enable the market to pivot back to an upward trajectory following the period of data testing the bottom.