Former Cleveland Fed Pres. Mester: High gas prices are salient for people's inflation perceptions

Mester states that the growth impact of an oil price shock will be less than in the 70s and 80s because "we now export energy. We're not an importer and we're more efficient at using energy." Historically, high oil prices triggered domestic recessions, destroying demand for energy. Because the US is now a net exporter, domestic energy producers can reap the windfall of elevated global oil prices (driven by geopolitical supply constraints) without suffering the same level of domestic demand destruction. LONG US energy majors and sector ETFs, as they are structurally positioned to capture high margins in a macro environment where the US economy can uniquely withstand elevated energy costs. A sudden geopolitical resolution that floods the market with oil supply, or a severe global recession outside the US that destroys aggregate commodity demand.

Mester explicitly notes that due to inflation expectations and supply constraints, "in the near term, certainly they're on hold. And perhaps for the longer term they may have to be on hold." She adds the Fed will not forget the mistake of calling inflation transitory. The market frequently attempts to price in premature Fed rate cuts. If the Fed is structurally forced to keep the Fed Funds rate elevated for longer to combat sticky, energy-driven inflation expectations, long-duration bond yields will remain high or rise further. This inversely drives down the price of long-term Treasury bonds. SHORT long-duration Treasuries, as the "higher for longer" monetary policy regime is deeply entrenched by salient consumer inflation metrics. A sudden, unexpected collapse in the US labor market that forces the Fed to abandon its inflation fight and execute emergency rate cuts, sparking a massive bond rally.

Mester points out that "high gasoline prices is really salient for people's perceptions of inflation" and will make it much harder for the committee to ignore the oil price shock. High prices at the pump act as a direct, unavoidable tax on the consumer. When combined with the Fed keeping interest rates "higher for longer" (increasing credit card and auto loan costs), the consumer's discretionary income is squeezed from both ends. This directly impairs the revenue and margins of non-essential retail and consumer discretionary companies. SHORT consumer discretionary equities, as the sector faces the dual headwinds of reduced consumer spending power (via gas prices) and elevated borrowing costs. Real wage growth accelerates faster than energy prices, or consumers successfully absorb the costs by drawing down remaining excess savings without altering their spending habits.