Apollo's chief economist warns: The Federal Reserve may have overlooked the risks associated with diesel prices.

Torsten Slok, chief economist at Apollo Global Management, warned that the record diesel prices pose a far greater threat to inflation than the Federal Reserve currently assesses—because diesel costs will seep into the core consumer price index, which is precisely the key benchmark for the Fed's monetary policy.

Slok stated on Bloomberg TV's "Surveillance" program on Friday that the transmission path of transportation costs related to diesel is quite different from that of gasoline. Because transporting goods is essential to the retail supply chain and even data center construction, demand for diesel has extremely low price elasticity, meaning price increases will ultimately be passed on to businesses and consumers. "Diesel price increases actually go into other sub-categories of the CPI outside of the energy component," he said.

This statement echoes the divisions within the Federal Reserve. Chicago Fed President Austan Goolsbee warned this week that the central bank cannot ignore recurring and persistent supply shocks, stating that "once inflation triggered by supply shocks becomes sustained, part of the basis for the 'see through' logic no longer holds." Currently, US inflation remains well above the Fed's 2% target, leading to greater uncertainty regarding the direction of monetary policy.

Diesel fuels core inflation, posing a challenge to the traditional framework.

In a research report this week, Slok systematically elaborated on these views, directly pointing to the limitations of the traditional core inflation framework. He argues that core inflation measures that exclude food and energy prices are not applicable to key fuels like diesel.

“The rise in diesel prices will not remain in the energy component of the CPI, but will instead migrate laggingly to core goods and services. This is precisely the transmission mechanism that the Federal Reserve cannot characterize as a temporary factor,” Slok wrote in the report.

According to Bloomberg data, as of Thursday, the average price of diesel in the United States has surged 83% this year to $6.50 per gallon, while gasoline prices have risen by 59% over the same period. The conflict between the US and Iran has disrupted the flow of oil in the Persian Gulf, driving up energy prices across the board, but diesel users have been particularly hard hit.

Internal divisions within the Federal Reserve: Can the energy shock be "foreseen"?

The minutes of the Federal Open Market Committee meeting in July showed that most participants believed the previous rise in energy prices would gradually subside, helping to suppress inflation throughout the year. This assessment directly contradicts Slok's warnings.

However, following the Federal Reserve's September 16th rate hike—the first since 2023—Goolsbee's statements indicated a softening of his internal stance. He explicitly stated that the logic behind the "see-through" strategy would be weakened when supply-side-driven inflation is persistent.

Slok described an implicit policy expectation of the Federal Reserve: hoping that a resolution to the Iran war would alleviate energy price pressures, thus eliminating the need for further interest rate hikes. He called this scenario "the current all-or-nothing gamble."

Furthermore, Slok points out that the surge in AI-related spending is the primary reason for the resilience of the US economy in a high-interest-rate environment. He estimates that AI-related activities currently contribute about one percentage point to GDP growth, accounting for roughly half of current total growth. This contribution encompasses multiple channels, including data center construction, energy demand, software spending, and the wealth effect from high stock prices. Notably, data center construction itself is highly dependent on diesel demand, meaning there is a mutually reinforcing relationship between AI-driven economic expansion and rising diesel prices, further increasing the likelihood of persistent inflationary pressures.

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