Inflation and Employment Projections: US Neutral Interest Rate May Remain Elevated

Fxstreet, October 6th—— Stock shortages are pushing oil prices up and causing inflation to remain sticky; employment is softening but the fundamentals are still there, so the US neutral interest rate may remain high.

The future direction of the US neutral interest rate depends on two competing threads: one from energy, the other from employment.

Saudi Aramco CEO Nasser's inventory warning pushed the flexibility of oil-driven inflation to center stage — with less than 10% of global usable inventories remaining and restocking possibly taking up to two years, energy is making inflation "quick to rise and hard to fall." On the employment side, a micro-level analysis from the St. Louis Fed shows that demand actually peaked as early as April 2023, and the market is quietly shifting from extremely tight to relatively loose, subtly releasing some pressure on inflation.

The two forces largely offset each other, ultimately keeping policy rates anchored at a high plateau — precisely the theme of this article: how the tug-of-war between oil prices and employment determines the stubbornly high US neutral interest rate.

On the Oil Price Side: Aramco CEO’s Inventory Warning and Its Impact on US Inflation

Saudi Aramco CEO Nasser’s remarks at the London Energy Intelligence Forum centered on a warning of “dwindling reserves.”

His data was quite straightforward: before the crisis, global commercial stocks were about 10 billion barrels; now, it's down to less than 6 billion barrels, and truly usable inventories may be less than 10% of that—a level he called “scarily thin.”

The war has cumulatively caused a supply loss of about 3 billion barrels, and over 1 billion barrels of that gap has been plugged by inventory withdrawals, essentially using up the last buffer.

Even if the Strait of Hormuz fully reopens and confidence returns, rebuilding stocks could take two years;

To restock while serving daily demand, global supply will need an additional 2 million barrels a day over the next 18 months.

The impact on the US is concentrated in refined products: with Middle East refineries damaged, fuel prices have risen even faster than crude prices; meanwhile, Chinese refineries have halted fuel exports to secure domestic supply, keeping the diesel-gasoline crack spread elevated.

Gasoline and diesel are the most sensitive and heavily weighted components of the US CPI, and are direct expenses felt by consumers — every penny increase gets passed through the supply chain into broader pricing.

This means the energy side is acting as a “spring” making US inflation quick to rise and slow to drop: the thinner the inventory and the smaller the buffer, the more any new shock gets magnified into a sharp price spike, dragging out the disinflation process.

US Employment: The Real Temperature from a Micro Perspective

Insights from the latest research article by the St. Louis Fed reveal a market somewhat at odds with the macro numbers.

National unemployment has stayed at or below 4.5% for almost five years, one of the longest low-unemployment periods in modern history, and demand fundamentals are still present.

But what’s truly noteworthy is the composition—the peak of labor demand came in April 2023, and many regions have clearly cooled since then, though this cooling is diluted by the national average.

The most prominent micro-level signal is that “tightness dividends don’t guarantee immunity”: in areas hardest hit by the pandemic, young workers have shown weaker recoveries; and even in ultra-tight markets with long-term unemployment below 3%, young people’s accumulated job advantages don’t shield them from losses should the market slow.

In other words, the job market is transitioning from extremely tight to neutral with a slight lean toward looseness, with the most inexperienced and least skilled groups the first to feel a chill—their employment fragility is often the earliest yellow flag.

Employment Outlook: The Tug-of-War Between Resilience and Softening

Looking ahead, the labor market is almost like a “tug-of-war between resilience and slowdown.”

On one hand, unemployment remains low, job vacancies have fallen but not collapsed, and service sector demand is still providing some support; there are no imminent signs of a sharp downturn. On the other hand, with demand past its peak and structural divergence worsening, wage growth is slowing, laying the groundwork for more moderate price transmission—a possible harbinger of weaker inflationary pressure.

The key is pace: if employment only “cools moderately,” the Fed buys itself time to observe;

If the cooling turns systemic, it will suppress not just wages but overall demand—at that point, employment’s drag on inflation will directly confront upward pressure from energy.

The Direction of Neutral Rate: Stubbornly High

Bringing oil prices and employment together for the Fed, the direction for the neutral rate becomes clearer.

Energy supply shocks keep upward pressure on inflation, while employment is exerting gentle downward force—the result is inflation remaining on a stickier plateau than expected: not dropping quickly, nor spiraling out of control.

This environment makes the path of policy rate cuts cautious: as long as inflation remains sticky and energy buffers are thin, the Fed is unlikely to cut rates aggressively or consecutively, making the “higher for longer” path more probable.

In market terms: the future neutral rate is more likely to hover at a level slightly higher than at present, rather than dropping quickly.

For the dollar, this means strong support and limited downside; for gold and risk assets, persistently high rates remain a constraint.

The real variables still lie in two places—will oil prices spike again from new supply shocks, and will employment’s “moderate cooling” morph into an “obvious weakening”? The first would push inflation higher, the latter would drag down demand: whichever comes first will decide whether the neutral rate stays high or is forced to seek an exit lower.