Rising Oil Prices Weigh on Inflation

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The continued amplification of the conflict in the Middle East has created heightened uncertainty in financial markets. Crude oil in particular had a volatile week, beginning with a historic overnight spike to $119.50 last Sunday, March 8, as the effective closure of the Strait of Hormuz triggered immediate supply shock fears before retreating to $94.77 by Monday afternoon as investors weighed the possibility of a shorter conflict and potential government interventions.

Skyrocketing oil prices were accompanied by mixed inflation readings last week. The headline Consumer Price Index (CPI) inflation rate held steady in February at 2.4 percent annually, while core CPI, which excludes more volatile food and energy costs, rose a modest 0.22 percent for the month. This suggested that, according to this measure, inflationary pressures were holding steady before the recent energy shocks. However, the Federal Reserve’s preferred measure, Core Personal Consumption Expenditures (PCE) data for January—released on a lag due to the government shutdown—revealed a much hotter monthly increase of 0.4 percent. This pushed the annual core rate to 3.1 percent as of January 2026, the same level reached at the end of 2023. In other words, the Fed has made essentially no progress toward reaching its 2 percent inflation target over the past two years.

The acceleration of PCE—an inflation gauge preferred by the Fed because it excludes volatile food/energy prices as well as adjusts for consumer behavior—came on the heels of weak jobs data published the prior week, which showed that job growth has pulled back toward zero. Nonfarm payrolls averaged a mere 6,000 over the past three months, with the six- and nine-month averages residing at –1,000 and –4,000, while the year-over-year gain for February 2026 fell to just 0.1 percent.

This historically low growth rate reflects an economy that added only approximately 156,000 jobs over the entire 12-month period, averaging just 13,000 jobs per month (compared to the 124,000 monthly average in 2024) in a further sign of a softening labor market. This is a condition that has occurred only in periods of economic weakness in data stemming back to 1950. And while history can be an imperfect guide, we believe this continues to define the narrow and delicate balance the economy remains in: labor weakness but with still heightened and sticky inflation.

Factor in uncertainty surrounding tariff policy, the continued geopolitical unrest in the Middle East and an impending changing of the guard at the U.S. central bank following Kevin Warsh’s nomination to replace Jerome Powell as Fed chair, and monetary policymakers have their work cut out for them as they attempt to carry out the Fed’s dual mandate of stable prices and maximum employment.

All this and more will come to a head next week as the Federal Reserve’s Federal Open Market Committee (FOMC) prepares to meet this Tuesday and Wednesday. Markets are pricing in a nearly 100 percent probability that the Fed will keep interest rates steady given the combination of sticky inflation, poor jobs data and the recent geopolitical energy shock.

While labor weakness has been persistent for much of the prior year and a half, the good news is that the overall economy has continued to grow. That narrative took a bit of a hit with the release of sluggish revised gross domestic product (GDP) data last week, which showed that U.S. economy grew at a revised annualized rate of just 0.7 percent in the fourth quarter of 2025. However, a large amount of this pullback was due to the record-long 43-day government shutdown. Nonetheless, we note that economic growth continues to rest upon the shoulders of the current artificial intelligence boom, with information processing equipment and intellectual property products (two segments tied to AI and representing around 10 percent of overall annual spending) contributing 0.97 percent to overall growth of 0.7 percent.

While consumer spending remained resilient, recent data suggests a slowing, and we continue to note that this is being driven by higher-income consumers, with lower- to middle-income consumers continuing to feel the affordability pinch. Once again, we find ourselves in an interesting place with the potential for continued volatility given the myriad of economic and geopolitical risks that hang over markets. We remind investors that the proper response is not one of dramatic action or large shifts in portfolio construction but rather a continued steady hand. After all, your portfolio asset allocation already reflects the reality that these various outcomes have been and unfortunately will be future features of both economies and equity markets. This is what diversification is built for—having different assets that do well in different economic environments with the driving force behind one’s allocation being the financial plan, which is stress-tested against the reality that uncertainty spikes are just that—a historical and likely future reality.

Wall Street wrap

Prices remain sticky, per core inflation figures: Consumer Price Index (CPI) inflation held steady at 2.4 percent for the year in February, according to the Bureau of Economic Analysis (BEA), matching analyst expectations. While this does reflect a potential for a stabilizing inflationary environment, we note that it primarily captures the period before the recent conflict in the Middle East, which triggered a surge in global energy prices. On a monthly basis, it increased 0.3 percent.

Core CPI, which excludes more volatile food and energy prices, rose 0.2 percent for the month and 2.5 percent over the last 12 months, also in line with forecasts. Much of this advance was driven by the services industry, up 0.27 percent for the month and 2.9 percent year over year. Of particular concern given its connection to the potential for wage-driven inflation was another spike in Supercore services (also excluding shelter), which increased by 0.35 percent on the heels of a sharp 0.59 percent spike seen in January.

Meanwhile, core PCE inflation accelerated by 0.36 percent in January and 3.1 percent year over year, reflecting persistent price pressures. The report published last week by the BEA, delayed as a result of the government shutdown, also reflected an uptick in services inflation, with the sector up 0.38 percent for the month and 3.5 percent on a year-over-year basis. Supercore services, a category closely watched by the Fed that strips out housing costs—which often lag real-time market changes—went up 0.43 percent in January. Goods, on the other hand, rose a modest 0.05 percent after a sharp 0.38 percent advance in December.

Consumer sentiment dips following Middle East conflict: Preliminary data from the University of Michigan Consumer Sentiment Index released on Friday showed that consumer confidence fell to 55.5 from 56.6 in February, hitting a three-month low as consumers reacted to the onset of military conflict in the Middle East on February 28. Current conditions held steady, rising to 57.8 from 56.6, while the Expectations index fell to 54.1 from 56.6. “Consumer sentiment dipped about 2 percent, reaching its lowest reading of the year,” Surveys of Consumers Director Joanne Hsu noted. “Interviews completed prior to the military action in Iran showed an improvement in sentiment from last month, but lower readings seen during the nine days thereafter completely erased those initial gains.”

The good news is that inflation expectations—a key measure for the Fed that can show inflation is becoming embedded in consumer behavior—remained steady to slightly lower at 3.4 percent on an annual basis. The “long run” five-year inflation expectation outlook, meanwhile, inched down slightly to 3.2 percent from 3.3 percent in March. Both measures remain well above the 2.3 to 3.0 percent range seen in the two years pre-pandemic. However, the divergence between pre-conflict survey data and post-conflict market spikes suggests that upcoming inflation reports could see increased upward pressure.

“These developments will complicate Fed policy decisions,” the release noted. “Over the past nine months or so, consumer worries about inflation had eased, while labor market concerns escalated. This month’s survey highlights risks on both sides of the Fed’s dual mandate. Geopolitical escalations are reigniting fears about the trajectory of inflation, while at the same time various measures of labor market expectations remain weak. Unemployment expectations softened a touch, and real income expectations worsened across groups by income, education and political affiliation.”

Small business sales tick up despite rising uncertainty: The National Federation of Independent Business Small Business Optimism Index dipped 0.5 points to 98.8 in February, falling short of analyst expectations but remaining slightly above its 52-year historical average of 98. This continues a trend of being stuck in a narrow range of 98.2 to 100.8 since May 2025, following the “Liberation Day” tariff legislation market fallout. This second consecutive monthly decline was primarily driven by a sharp eight-point drop in real sales expectations, erasing a strong gain from January, as well as a pullback in hiring plans for the next three months to 12 percent from 16 percent in January—a significant deviation from November’s 19 percent high and tied for the lowest hiring plans since May 2025, with only March 2024 being lower in the post-COVID economic cycle.

Earnings trends emerged as the strongest component of the index, surging seven points from January to a net negative 14 percent. This represents the highest reading for profitability since December 2022. This was driven primarily by a significant rebound in actual nominal sales, which also jumped seven points to a net 1 percent—the best performance for actual sales since May 2022, bringing the metric back in line with its long-term historical average of 0 percent.

Meanwhile, business owners reported feeling more certain about the future, with the Uncertainty Index decreasing three points to 88. While a welcome decrease from the record highs seen in late 2024 (which peaked at 110), the figure remains elevated compared to historical norms. Taxes replaced labor quality as the single most important problem cited by owners, with nearly a fifth of respondents identifying it as their top concern. We emphasize that this survey was compiled prior to the Middle East conflict but reflected an improving outlook overall despite slower hiring.

GDP slows in Q4, but AI remains a bright spot: The U.S. economy expanded at a sluggish annualized rate of 0.7 percent in the fourth quarter of 2025, according to a second estimate on GDP growth from BEA released last week, a significant downward revision from the initial 1.4 percent estimate. It also marks a significant reversal from the 4.4 percent growth charted in Q3 2025. For the full year of 2025, the U.S. economy grew by 2.1 percent, a step down from the 2.8 percent growth recorded in 2024.

Much of this slowdown resulted from the 43-day shutdown in late 2025, which stripped 1.16 percentage points from overall growth as federal government spending and investment plunged by 16.7 percent. Personal consumption expenditure (consumer spending) growth was also revised down to 2.0 percent from the initially forecasted 2.4 percent, signaling a slight cooling in household demand compared to the 3.5 percent surge in the previous quarter. Exports declined at a 3.3 percent annual rate, a deeper contraction than the previously estimated 0.9 percent drop, while nonresidential fixed investment grew at a moderated 2.2 percent pace, down from the initially reported 3.7 percent.

While overall GDP growth was revised weaker, business investment in the information processing and intellectual property products categories remained a key driver of growth, helping to offset sharp declines in federal government spending and exports in a demonstration of how AI investment is helping keep the current bifurcated economy chugging along. Specifically, information processing rose 37 percent, driven by an 81 percent surge in computers and peripheral equipment, contributing to 0.66 percent of the total 0.7 percent GDP growth. Likewise, intellectual property products rose 5.7 percent and contributed 0.31 percent to total GDP growth.

Consumer spending rises with inflation: The BEA also released personal income and spending data from January, which showed solid nominal income growth, up 0.4 percent in the first month of 2026. While nominal spending rose, however, inflation essentially neutralized most of those gains. Real PCE rose by 0.1 percent in January—following back-to-back 0.1 percent increases in December and November—while the Fed’s preferred PCE Price Index rose 0.3 percent for the month, meaning consumers had to spend more just to maintain nearly the same level of consumption.

The week ahead

Tuesday/Wednesday: The U.S. central bank’s FOMC is scheduled to meet this Tuesday and Wednesday and will release its official interest rate decision on Wednesday at 2:30pm EST. As discussed, officials are widely expected to keep rates steady in the 3.50–3.75 percent range due to “sticky” core inflation.

Wednesday: February Producer Price Index inflation data will be released at 8:30am EST. This data is particularly significant, as it arrives on the same day as the FOMC interest rate decision. We will be monitoring for signs of sticky inflation to see if wholesale price trends align with last week’s CPI and PCE readings.

Thursday: The Fed will release the Financial Accounts of the United States at 12:00pm EDT, containing data on the change in net worth for U.S. households and nonprofit organizations for the fourth quarter of 2025. In the previous quarter, net worth reached a record $181.6 trillion, driven largely by gains in corporate equities.

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