Viewpoints

In recent months the maritime supply chain of oil and petroleum, especially via the Middle East, has come under immense strain. The ongoing disruptions to sensitive maritime chokepoints make the economics around it increasingly precarious. The Strait of Hormuz has been heavily restricted since March 2, 2026 and as of August 30, 2026 remains effectively closed. According to the EIA, prior to the conflict roughly a fifth of global oil consumption and LNG trade flowed through this chokepoint. There was a partial opening that lasted from June 17, 2026 to July 14, 2026. More recently on July 20, 2026 Yemen’s Houthi movement declared a naval blockade and maritime embargo on Bab el Mandeb strait. Together, the two disruptions have exposed the limited scope for rerouting and increased the risk of a more persistent energy-price shock. In this piece, we examine their impact on tanker shipping routes and Saudi Arabia’s oil trade, using IMF PortWatch data available in Haver’s TRANSPRT Database.

A closer look at chokepoints: Limitations of rerouting

In the month following the closure of Strait of Hormuz, tanker trade volume through Hormuz collapsed to 22.8 thousand tons from 1.97 million tons over the previous 30 days. This difference in lost volume was not absorbed by the aggregate of the remaining chokepoints – Suez Canal (Egypt), Bab el Mandeb (Yemen) and Cape of Good Hope (South Africa) – as the net volume through the alternate corridor remained nearly steady and has actually begun to fall off in the latest month (Figure 1 Blue line).

There were some significant gains made during the partial reopening from June 17 to July 14, where Hormuz tanker volume regained 29.5 percent of its original value. However, the Houthi blockade (July 20) triggered a second, compounding decline, this time visible on all three lines (Figure 1). Hormuz dropped again, and the alternate corridor (which had shown slight gains at that time) dropped as well. These were not two independent shocks; the second disruption hit the very route ships had been relying on to cope with the first.

The US has maintained a strong naval presence in the region and has led Operation Prosperity Guardian, a multinational coalition set up in December 2023, which aims to protect commercial shipping in the Red Sea. The challenge is the asymmetry of the threat from the Houthis: cheap drone and missile attacks on tankers and naval escorts are hard to fully deter, so even a partial or a threatened blockade has proven effective.

The employment report confirmed that the labor market is roughly in equilibrium. Now focus shifts to the August inflation data. I think a rate hike is quite likely on the 15th if the August data either match or exceed consensus forecasts.

In times like this, data dependence make sense

The Fed is often criticized for being too “data dependent.” Critics argue that tying policy to upcoming data: (1) makes the Fed backward looking, (2) adds to volatility as markets over-react to each release, and (3) signals the lack of a fundamental framework.

I disagree. After a period of hawkish or dovish news, there is always a period of high data dependence. At that stage incoming data becomes the final straw. In this instance high and rising inflation (chart) has created a strong focus on the August inflation data. After 65 months of above-target inflation, every member of the FOMC wants to hike if inflation does not return to target in a “timely manner.”

Kevin Warsh used his first Jackson Hole address as chairman of the Federal Reserve last week to signal that the next move in US interest rates is more likely to be up than down. He is not alone. The European Central Bank raised rates in June and may go further, and several other central banks have turned hawkish. It is a puzzle. Growth has slowed, unemployment has drifted up, and core inflation across the advanced economies is not far above target. Why is the world's monetary tide turning towards tightening?

The official answer is that they are guarding against a shift in expectations. Supply-driven inflation need not persist; it does so only if firms and households come to expect it, and set wages and prices accordingly. Having misjudged the 2021 shock as transitory, central bankers are unwilling to take that chance a second time. So they are tightening not to reverse the shock, which no rate can do, but to keep expectations anchored.

That, though, is the lesser part of the story. The central banks are treating as a cyclical episode what is in truth a change of regime. For a generation the advanced economies enjoyed abundant supply and abundant capital: globalisation held down the price of goods, a global surplus of saving held down the price of money, and monetary policy had only to manage demand. Both conditions are now reversing, together. Supply has become scarce and costly; so has capital; and the two are related. The consequences are large. Inflation of this kind cannot be brought down by interest rates, only resisted at the cost of a recession. The real cost of capital has risen durably, not cyclically. And investors positioned for the old regime — a central bank that eases into every downturn, government bonds that hedge equities, real rates that subside to their former lows — are positioned for a world that will not return.

Supply has tightened on every front. In the past month alone the United States imposed 50 per cent tariffs on Canadian goods; American forces struck Iranian launchers at the Strait of Hormuz, returning Brent above $90; and a glacier collapse on the Nepal-Tibet border destroyed a regional trade route. Each raised costs, and none can be addressed by a policy rate. To these has been added a contraction in the supply of labour. The administration's immigration enforcement, recently extended to withdraw work authorisation from more than a million people, has reduced the workforce available to construction, agriculture and services, and raised wage costs in those sectors. None of this is a temporary deviation from a stable trend. The real cost of energy has risen for a quarter of a century to a record; reshoring is reconstructing supply chains at higher cost; and demographic change was tightening labour markets before enforcement intensified. The cheap and frictionless supply of the globalisation era has ended.

The data bear this out. Decompose US core inflation into demand- and supply-driven components and the demand-driven part has fallen to around one percentage point, with supply accounting for almost the entire excess over target (Figure 1). Across the G10, core rates are grouped close to target, none much above two and a half per cent (Figure 2). The demand that monetary policy governs has already been contained; wage growth is slowing, and market-based measures of inflation expectations remain near target. What sustains inflation above target is supply.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in July showed modest to moderate growth. In the one-month changes, six states-scattered across the nation--had increases greater than .5 percent (Washington, Nevada, Rhode Island, South Carolina, North Dakota, and Wyoming). Hawaii and Alabama saw declines. Over the three months ending in July six states (West Virginia, Rhode Island, South Carolina, Delaware, Nevada, and New Hampshire) had increases above 1.5 percent. Kentucky, Hawaii, and Alabama had declines , with Alabama’s index down a marked 1.34 percent. Over the last twelve months, no state saw an increase of 4 percent or more—Nevada’s 3.76 percent was the highest (six other states had increases above 3 percent). Alabama and Connecticut were down, and six others saw increases of less than one percent. r percent (Idaho was up 3.62 percent), and six others were at or higher than three percent.

The independently estimated national estimates of growth over the last three and twelve were, respectively, .54 and 1.88 percent. Both measures appear to be a bit lower than what the state numbers would have suggested.

My key observation about the current angst about “high” bond yields: I much prefer high real interest rates associated with healthy economic growth and high returns to capital than low real interest rates associated with economic malaise and low expectations.

Also, while I have long argued that the persistently high government budget deficits and rising debt/GDP are a major problem that involve a misallocation of national resources and must be addressed, I’m not so sure that the recent rise in rates can be attributable to the government’s rising debt.

It’s a tossup between what was more illogical last week, the headlines lamenting “soaring bond yields” or U.S. Secretary of the Treasury Scott Bessent’s announcement that the Treasury had upped its bond buyback program with the hope of lowering yields on long-duration Treasury securities.

A bit of historical perspective is instructive. Current yields are not “soaring” or even “high”—they are in a range that is consistent with current economic and inflation conditions—and these levels are preferable to the low bond yields that characterized the troubled post-Great Financial Crisis period. And Bessent’s Wall Street career in fixed income presumably taught him that interventions aimed at manipulating the bond market would not work; clearly, his announced intervention was a political ploy to placate President Trump. It didn’t work. I strongly recommend Stanley Druckenmiller’s Wall Street Journal article “Let the Bond Market Speak”, August 24, 2026.

Currently, 10-year US Treasury yields are roughly 4.7%, up from 4.2% earlier in 2026. With inflationary expectations around 2.25%, real rates are in the 2.4%-2.5% range. It’s likely that real rates would be even higher if not for the Trump Administration’s tariffs, clampdown on immigration and other policies that have dampened real growth and threatened longer-run potential. Current real rates are above the low bond yields during 2010-2014 (they ranged between 2.5%-3.25%) that were associated with the disappointingly soft economic recovery from the Great Financial Crisis, lingering high unemployment and diminished expectations, the Fed’s zero interest rates and extended asset purchases and worries that inflation was too low, but significantly below the bond yields of the 1990s and modestly below those that prevailed during portions of the early 2000s.

A cursory comparison of recent decades suggests clearly that the post-GFC period was aberrant period. (Federal Reserve Bank of New York research “Measuring the Natural Rate of Interest”, 2026, estimates that the 2009-2014 period was the low point of the natural rate in modern history.) Yet many financial market participants and commentators use the low rates of that aberrant period as the benchmark for characterizing current yields as high and rising, when economic conditions are far different.

Chart 1 shows 10-year Treasury bond yields and core PCE inflation since 1990. Chart 2 shows the inflation-adjusted bond yields (a measure of inflationary expectations is not available back to 1990) and their correlation to productivity gains.

A surge in productivity growth could solve a lot of problems. It would mean higher government revenue and, combined with spending discipline, lower the budget deficits. Indeed, it is the centerpiece of Treasury Secretary Bessent’s deficit reduction plan. It could also mean easier Fed policy: if productivity increases are not matched by higher compensation growth, unit labor costs and inflation weaken, allowing the Fed to ease rather than hike. This was Warsh’s argument for rate cuts early this year (and he continues to talk about how great productivity is).

The case for and against a surge

Both Administration economists, and Warsh during his campaign for Fed chair, argue that growth-friendly Administration policies and the AI revolution mean higher trend growth. Tax cuts, they argue, stimulate investment and labor supply, while deregulation increases economic efficiency.

I’m skeptical for three reasons. First, we have seen this movie before, and it had a flat ending. Starting with President Carter and continuing with Reagan there was a major push for deregulation in the 1970s and 1980s. Indeed, it was much bigger than what Trump is doing. Reagan also implemented major tax cuts in marginal tax rates. Again, they were much bigger than what Trump has implemented.

And yet, history shows there was no pick-up in productivity or trend growth during this period. With the benefit of hindsight, the CBO has good estimates of what happened to trend growth during and following the “Reagan revolution.” They show productivity initially rebounding from the 1982 recession but then fading for the rest of the recovery (chart). A sustained pick-up did not happen until the “new paradigm” technology boost, starting in 1995.

In my youth, I co-authored a paper on The Supply-Side Consequences of U.S. Fiscal Policy in the 1980s at the NY Fed. We found early evidence that supply-side indicators, like investment, productivity and the labor supply did not respond to the policy changes. We then used a simple simulation model, to show that the crowding out of investment from surging budget deficits offset the benefits of lower marginal tax rates and deregulation. The CBO numbers confirmed those preliminary findings.

Starting on August 27, 2026, and running through August 29, 2026, the Federal Reserve Bank of Kansas City will host its annual “barbecue” in Jackson Hole, Wyoming. The best and the brightest of monetary policy gurus from around the world will be there and the highlight of every conference is the comments by the chairman of the Federal Reserve Board. (For some reason, my invitation has repeatedly been lost in the mail.) The theme of the 2026 conference is “Financial Innovation: Implications for Payments Policy”. Although this is an important topic, is it really the most pressing issue for the Federal Reserve to be considering? Of course, I am biased, but I believe that Fed should be discussing a superior way to conduct its monetary policy so as to more consistently achieve an inflation target, especially in an environment of random shocks to the aggregate supply of real goods and services. For whatever reason, these random shocks seem to have been occurring more frequently in recent years. So, I humbly suggest that Fed Chairman include in his remarks that the Federal Reserve operate in a manner such that the sum of depository institution reserves and the securities and loans on the books of depository institutions grow at some constant rate. (Depository institutions are commercial banks, saving institutions and credit unions. Commercial banks dominate depository institutions.) In what follows, I will provide empirical evidence demonstrating that growth in the nominal annual averages of this sum, let us call it “thin-air” credit, has a relatively high correlation with future growth in the nominal annual averages of domestic aggregate demand and the future rate of inflation associated with domestic aggregate demand. In addition to having relatively high correlations with growth in nominal domestic aggregate demand and the associated inflation rate, a constant rate of growth in “thin-air” credit will prevent cumulative increases or decreases in the rate of inflation. I will provide the rationale for why I believe 5-1/2 percent would be a reasonable target rate of growth in thin-air credit. I also will explain how the Federal Reserve can achieve, with precision, whatever target rate of thin-air credit growth it chooses without operating via a federal funds rate target. Not only would this modest proposal eliminate persistent overshoots and undershoots of the Fed’s inflation target, it would simplify the Fed’s communication challenges. In terms of forward guidance, all the Fed chairman would need to say at the end of every Federal Open Market Committee (FOMC) meeting is that the committee intends to have the sum of depository institution reserves plus securities and loans grow at a steady annual rate of 5-1/2 percent.

Plotted in Chart 1 are the year-over-year percent changes in the annual averages of the sum of depository institution reserves at the Federal Reserve, securities and loans (the blue bars) and the year-over-year percent changes in the annual averages of nominal Gross Domestic Purchases (the red line). (Monetary policy primarily influences domestic aggregate demand. That is why I have chosen nominal Gross Domestic Purchases as the “dependent” variable rather than Gross Domestic Product, because the latter involves exports, which is more of a function of foreign demand for US goods and services.) The gray shaded areas represent periods of recession. The highest correlation between these two series starting with 1955 data occurs when thin-air credit is advanced by one year. That correlation is 0.52 (shown in the upper left corner of the chart). This implies that growth in thin-air credit leads growth in nominal Gross Domestic Purchases by one year. So, what happens to thin-air credit this year has its largest effect on nominal Gross Domestic Purchases next year.

State labor markets were fairly stable in July. One state (Maryland) reported a statistically significant increase in jobs, and one state (New Jersey) clocked a significant decline. A full 10 states saw statistically significant drops in their unemployment rate, though none was larger than .2 percentage points. The highest unemployment rates were in DC (5.9%), Connecticut (5.2%), Oregon (5.2%), California (5.1%), Nevada (5.0%), and Washington (5.0%). Nebraska, New Hampshire, Hawaii, Vermont, North Dakota, and South Dakota had unemployment rates under 3.0%, while South Dakota’s 2.0% was the lowest in the nation.

Puerto Rico’s unemployment rate moved up to 6.0% and the island’s job count moved up by 2000.