U.S. diesel prices surge 83% this year! Apollo Chief Economist warns: Cost pass-through may make core inflation more stubborn, Federal Reserve can't ignore it

According to English Finance APP, Apollo Global Management's Chief Economist Torsten Slok has warned that the inflation threat posed by the surge in US diesel prices to historical highs could be more serious than the Federal Reserve currently realizes. Unlike gasoline price increases, which mainly reflect directly in energy expenditures, diesel costs are widely present in economic activities such as goods transportation, retail supply chains, and data center construction, and thus could further filter into the core Consumer Price Index (CPI). In an interview on Friday, Slok said: "When diesel prices go up, it actually enters categories in the CPI basket beyond just energy items."

This is particularly important for the Federal Reserve's current monetary policy. The Fed has just implemented its first rate hike since 2023, while US inflation remains significantly above its 2% target. Since core inflation metrics exclude energy prices, Slok believes the Fed cannot simply treat the spike in diesel prices as a temporary energy shock because higher transport costs could eventually seep into the prices of core goods and services.

After the US-Iran war disrupted crude oil supplies in the Persian Gulf, American consumers have already been facing upward pressure on gasoline prices, but businesses and the transport industry—those dependent on diesel—have borne an even heavier blow. As of Thursday, the average US diesel price had soared 83% so far this year, reaching $6.50 a gallon; in comparison, gasoline prices rose 59% over the same period.

Slok points out that there are important differences in the impact of diesel and gasoline on inflation. Diesel is widely used in the transportation of goods, with logistics activities being indispensable for both retail supply chains and data center construction. Moreover, the demand for this kind of activity is relatively price inelastic, meaning that even with significant increases in diesel prices, companies find it difficult to significantly reduce necessary transportation. This means that as fuel costs rise, transportation businesses may have to pass on increased costs to other companies, eventually filtering down to consumers.

Therefore, the impact of rising diesel prices will not be confined only to the "energy" category in the CPI but will likely spread through multiple channels such as logistics, goods, and service prices, creating more persistent upward pressure on core inflation.

Slok believes that this "second-round transmission" is exactly what differentiates the diesel price shock from ordinary energy price fluctuations. If it were only a short-term increase in gasoline prices, the Fed would usually focus more on core inflation trends that exclude energy and food. But if higher diesel prices raise the costs of goods transportation, construction, and business operations, and ultimately reflect in other goods and services, then the energy shock could turn into broader inflationary pressure.

In such a scenario, the Federal Reserve may find it more difficult to regard rising energy prices as a one-off, temporary shock. The issue is attracting particular attention now because the Fed has just resumed rate hikes. If diesel prices remain high and further push up core inflation, the Fed's challenge in controlling prices may grow even greater.

Meanwhile, Slok believes the AI investment boom is the most important reason the US economy remains resilient despite the high interest rate environment. He estimates that current AI-related economic activities contribute about 1 percentage point to US GDP growth, accounting for roughly half of the current overall economic growth.

This contribution comes not only from data center construction, but also includes energy demand generated as a result, software spending, and the wealth effect brought by stock market gains.

In other words, the US economy is currently being driven by two forces. On the one hand, the AI investment boom continues to support economic activity and demand; on the other hand, soaring energy costs such as diesel are pushing up operational and transportation costs for businesses and could further filter into inflation.

This also creates a more complex policy environment for the Federal Reserve: economic growth remains resilient, but inflationary pressure may become even more persistent as energy costs diffuse into core prices.

Slok also described a scenario that could allow the Fed to avoid further rate hikes. If the US-Iran war is resolved and the pressure on global energy supply is alleviated, oil and diesel prices may fall, thereby reducing inflationary pressure. In this scenario, the Fed may not need to suppress prices through further rate hikes.

However, Slok believes that easing Middle East tensions and driving down energy prices may be the Fed's best hope for avoiding further rate hikes at the moment, but whether this result can be achieved remains highly uncertain.