Everything is connected to everything else. – Barry Commoner, “The Closing Circle”
Everything is connected to everything else.
A gallon of diesel and a 30-year mortgage normally have little in common. Diesel prices are shaped by global crude and refined-product markets; mortgage rates reflect U.S. Treasury yields, monetary policy and conditions in the mortgage market. Over long periods, there is little reason for these two to move together. This year is different. The national average diesel price has climbed to a record above $6.50 per gallon, while the 30-year mortgage rate is approaching 7%. For two prices that normally have little in common, both are now uncomfortably close to a 7 handle.
The first phase of the war with Iran produced a long-feared oil price surge, but strategic inventories, weaker demand and an eventual truce helped limit the economic impact. Renewed hostilities arrived after global oil inventories had already substantially fallen, and the shock has increasingly spread beyond crude oil into refined products. Tight supplies and elevated crude prices have pushed diesel sharply higher, with distillate refining margins reaching record levels.
Diesel powers freight, farming, construction and much of the physical distribution system, extending its reach far beyond the fuel pump. In August alone, diesel prices in the Producer Price Index jumped 24.1% and accounted for more than one-third of the increase in final-demand goods prices. Gasoline is the energy price consumers notice most readily; diesel is embedded in the cost of producing and transporting much of what they buy. As veteran Wall Street commodities expert Jeff Currie recently put it, “Every other commodity is dirt plus diesel,” a reminder of how deeply fuel costs are embedded in mining, agriculture and transportation.
The longer the energy shock persists, the harder it becomes to contain its impact on interest rates. Last week, Between the Lines highlighted the competition for capital created by heavy government borrowing and the AI infrastructure buildout When Washington and AI Compete for Capital. The war has added an inflationary impulse to bond markets already absorbing heavy public and private borrowing. Higher inflation and greater uncertainty have put pressure on central banks to maintain restrictive policy and have helped keep longer-term government yields elevated. Last week, the Federal Reserve raised its policy rate 25 basis points to a 3.75%-4.00% range as inflation remained elevated.
American households might not follow distillate crack spreads, sovereign term premia or the expected path of the federal funds rate, but they do understand the cost of financing a home. The same conflict contributing to record diesel prices is also part of the inflation and interest rate backdrop that has pushed the 30-year mortgage rate toward 7%. Diesel prices do not determine mortgage rates, but this year the forces pushing both higher increasingly trace back to the same shock.
An energy supply shock can squeeze households in two directions: Higher transportation and production costs erode purchasing power, while persistent inflation keeps borrowing costs from providing the relief that often accompanies weaker growth. A war thousands of miles away is making its presence felt across financial markets and household budgets, from the cost of moving goods across America to the cost of financing a home.
Between the Lines is a weekly blog by DoubleLine Portfolio Managers Sam Garza, Joseph Mezyk and Quant Analysts Fei He, CFA and Sunyu Wang that breaks down topical macro and market issues. For questions or suggestions please e-mail us at betweenthelines@doubleline.com. The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of DoubleLine Capital LP, its affiliates or employees.
