The Big Idea

Fuel for the consumer

| December 9, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The spike in energy costs that followed the Russian invasion of Ukraine early this year put a substantial drag on household budgets and led to fears of a recession.  But during the summer and fall, the worst fears of global energy supply disruptions failed to play out, and gasoline prices in the US have steadily fallen.  Prices at the pump have dropped below levels prevailing immediately before the war, a tailwind that should help to bolster household finances heading into early 2023.

Prices at the pump

According to AAA, the national average for retail regular unleaded gasoline prices surged from around $3.50 a gallon just before Russia invaded Ukraine in February. The price peaked in June at just above $5, more than a 40% jump.

Nominal spending on gasoline increased from a $415 billion annualized pace in January to a peak of $583 billion in June. Volumes actually dropped slightly over that period, so the increase of nearly $170 billion annualized in outlays for motor fuel entirely reflected higher prices. The drag on household budgets represented close to 1% of disposable income, not enough to derail the consumer but sufficient to create a noticeable drag on budgets.

Thankfully, prices at the pump fell almost as quickly as they had risen.  In fact, by Thursday, the national average for regular unleaded gasoline had fallen to $3.33 a gallon, the lowest level since January (Exhibit 1).

Exhibit 1: Regular unleaded retail gasoline prices rise and fall

Source: AAA.

Thus, while inflation generally has taken a toll on household finances, sinking gasoline prices have been offering a boost to budgets since mid-year.

Near-term outlook

Gasoline futures tend to lead retail pump prices by about a month or so.  Futures prices have continued to slide in recent days.  While this partly reflects the normal seasonal pattern, the ongoing fall suggests that pump prices may continue to decline heading into 2023.  The historical relationship between the current gasoline futures contract and the AAA regular unleaded price tends to be tight (Exhibit 2). The futures price as of December 8 points to retail gasoline prices sinking by another 25 to 30 cents over the next month or two, perhaps approaching $3 a gallon, a level not seen since the spring of 2021.

Exhibit 2: Gasoline futures and pump prices show a tight link

Source: AAA, Bloomberg.

In all, the slide in gasoline prices from the peak in mid-2022 offers relief to the consumer of close to $200 billion annualized, or about $15 billion to $20 billion a month.  While this amount is not likely enough to make or break the economy, it represents more than 1% of total consumption. Presuming that every dollar not spent on gasoline is used to purchase something else, the cumulative boost to real consumer spending would be on the order of about 1%, boosting real spending growth from 0% to 1% or from 1% to 2%.  This may help to explain why consumer spending appears to be on a path to accelerate noticeably in the fourth quarter.

Inflation impact

The slide in gasoline prices since mid-year has also helped to tamp down headline inflation.  If gasoline prices slide to just over $3 per gallon by the end of the year, as the futures contract suggests, that would amount to a nearly 40% drop, or about 30% after seasonal adjustment (gasoline prices usually decline in the second half of the year), from the high.  In the CPI, gasoline represents about 4% of the overall index.  Thus, that slide in gasoline prices would be worth about 1.2 percentage points, accounting for the majority of the deceleration in the year-over-year advance in the headline CPI that I expect, from a peak of 9.0% in June to around 7% in December.

Unfortunately, Fed officials, in their efforts to bring inflation under control, cannot count on gasoline prices to continue to fall as they have over the past six months.  It is also worth noting that the year-over-year increase in the CPI for December, which may be close to 7%, comes with gasoline prices, often the primary driver of big price swings, roughly unchanged over the past 12 months.  That speaks to the breadth of the current inflation problem and suggests that the Fed has much work left to do.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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