U.S. diesel prices have surged 83% year-to-date! Apollo's chief economist warns: cost pass-through could make core inflation more stubborn, and the Fed will find it hard to look the other way.

Apollo Global Management chief economist Torsten Slok warned that the inflation threat from U.S. diesel prices surging to record highs could be more serious than the Federal Reserve currently realizes. Unlike gasoline price increases, which mainly show up directly in energy spending, diesel costs are embedded broadly across economic activities such as goods transportation, retail supply chains and data center construction, and could therefore feed further into core consumer price index (CPI). "When diesel prices go up, it actually goes into other categories than energy in the CPI basket," Slok said in an interview on Friday. This is particularly important for the Fed's current monetary policy. The Fed has just implemented its first rate hike since 2023, while U.S. inflation remains clearly above its 2% target. Because core inflation measures exclude energy prices, Slok argued that the Fed cannot simply treat the diesel price surge as a temporary energy shock, since higher transportation costs could eventually seep into core goods and services prices. After the war between the United States and Iran disrupted crude oil supplies in the Persian Gulf, U.S. consumers are already facing pressure from higher gasoline prices, but businesses and the transportation industry that rely on diesel are bearing an even sharper blow. As of Thursday, average U.S. diesel prices had surged 83% year-to-date to $6.50 per gallon, compared with a 59% rise in gasoline prices over the same period. Slok noted that there is an important difference between the inflation effects of diesel and gasoline. Diesel is widely used in goods transportation, from retail supply chains to data center construction, and such demand has low price elasticity, meaning that even if diesel prices rise sharply, businesses can hardly reduce necessary transportation activity significantly. This means that as fuel costs rise, transportation companies may have to pass on the increased costs to other businesses, which ultimately feed through to consumers. As a result, the impact of higher diesel prices will not remain only in the "energy" category of CPI, but may spread through multiple channels such as logistics, goods and services prices, putting more persistent upward pressure on core inflation. Slok believes this "second-round pass-through" is precisely the key difference between a diesel price shock and ordinary energy price fluctuations. If it were only a short-term rise in gasoline prices, the Fed could usually focus more on the core inflation trend excluding energy and food. But if higher diesel prices push up goods transportation, construction and business operating costs and ultimately show up in other goods and services prices, then an energy shock could turn into broader inflation pressure. In that case, it may be harder for the Fed to regard higher energy prices as a one-off temporary shock. The issue is drawing particular attention now because the Fed has just restarted rate hikes. If diesel prices remain elevated and further push up core inflation, the pressure on the Fed to control prices may increase accordingly. At the same time, Slok believes the artificial intelligence investment boom is the most important reason the U.S. economy remains resilient in a high-interest-rate environment. He estimates that AI-related economic activity currently contributes about 1 percentage point to U.S. GDP growth, equivalent to roughly half of overall economic growth at present. That contribution comes not only from data center construction, but also from the resulting energy demand, software spending and the wealth effect from rising stock prices. In other words, the U.S. economy is currently being affected by two forces at once. On one hand, the AI investment boom continues to support economic activity and demand; on the other hand, surging energy costs such as diesel are increasing business operating and transportation costs and may further feed into inflation. This also leaves the Fed facing a more complicated policy environment: economic growth remains resilient, but inflation pressure may become more stubborn as energy costs spread into core prices. Slok also described a scenario in which the Fed could avoid further rate hikes. If the war between the United States and Iran is resolved and global energy supply pressure eases as a result, oil and diesel prices could fall back, reducing inflation pressure. In that case, the Fed might not need to suppress prices through further rate hikes. However, Slok believes that a de-escalation in the Middle East that brings energy prices down may be the Fed's biggest hope for avoiding further rate hikes right now, but whether that outcome can be achieved remains highly uncertain.