Market Snapshot: Inflation, Oil Prices, and the Fed with Matthew Luzzetti

A monthly podcast examining the forces shaping markets and the broader economy.

In the inaugural episode, SIFMA President and CEO Kenneth E. Bentsen, Jr. and Head of Research Heidi Learner are joined by Matthew Luzzetti, Chief U.S. Economist and Head of U.S. Economic Research at Deutsche Bank, to discuss the evolving macroeconomic backdrop, including inflation risks, oil prices, higher interest rates, fiscal pressures, AI, and the outlook for the U.S. economy.

You can listen to this conversation by following “The SIFMA Podcast” on Apple, Spotify, YouTube, or wherever you get your podcasts. Sign up to receive new episodes, delivered right to your inbox.

In This Episode

• The recent oil price shock and implications for the broader U.S. economy
• Inflation dynamics and the outlook for Federal Reserve policy
• Treasury yields, fiscal pressures, and debt servicing costs
• The rise of 0DTE options and what the data says about market volatility
• AI’s potential impact on inflation, productivity, and economic growth
• Key risks and signals markets may be underappreciating

Featured Guest

Matthew Luzzetti

Chief U.S. Economist and Head of U.S. Economic Research
Deutsche Bank

Matthew Luzzetti leads Deutsche Bank’s U.S. economics research team, covering the macroeconomic outlook, Federal Reserve policy, inflation, labor markets, and broader market trends.

Transcript

(Edited for Clarity)

Kenneth E. Bentsen Jr.: Hello, and thank you for joining us for this first episode of “The Market Snapshot.” I’m your host, Ken Bentsen, President and CEO of SIFMA.

“The Market Snapshot” is a new monthly podcast that takes a concise look at what moved markets and what to watch next. Each episode explores notable market developments, highlights key takeaways from SIFMA’s recent research, and features perspectives from leading economists and strategists across the industry.

We focus on data, what’s driving markets, and the signals to watch going forward. This month, we’re discussing the evolving backdrop, rising inflation risks, higher rates, fiscal pressures, and how emerging forces like AI are shaping the outlook.

I’m pleased to be joined by my co-host, Heidi Lerner, SIFMA’s Director of Research and soon, we’ll be joined by Matt Luzzetti, Chief U.S. Economist and Head of U.S. Economic Research at Deutsche Bank. Comments and questions are welcome. Listeners can reach us at digital@sifma.org.

So, let’s get started. First, a recap on the markets. We’re recording this on Thursday, May 7th. Last week, the Fed announced its decision to maintain the target range for the federal funds rate at 3.5% to 3.75%. The major indices are trading near the top of their 52-week ranges, and U.S. debt has now surpassed 100% of GDP.

Heidi, the April edition of SIFMA’s Insights Market Metrics and Trends Report highlights the sharp rise in zero-day options, or 0DTE options. They’ve grown from about 18% to 29% of overall options activity, and in some areas of the market, their share is even higher, reaching 59% of SPX options contract volume in March. Some have suggested this growth could increase market volatility. Your report examines academic research that suggests otherwise. What did you find?

Heidi Learner: While it does seem like index option volumes are higher on days when there’s been a large decline in the market — which we define as a decline of more than 1% in the S&P — academic research suggests this is correlation, not causation. Market makers are generally long exposure to markets with customers selling large amounts of short-dated options, and that makes market makers sell into rallies to hedge their exposure, which has the effect of stabilizing the market and potentially reducing volatility.

Bentsen: So, let’s bring in Matt. Matt, thank you for joining us.

Matt Luzzetti: Thanks very much, Ken and Heidi. It’s great to be here.

Bentsen: Matt, you recently published a report, “The Oil Drumbeat of War.” How has the recent oil price shock changed your outlook for the U.S. economy?

Luzzetti: This was our first Outlook update since November, and I think the context of what’s going on is hugely important. There is a very strong historical regularity with which big oil price shocks tend to occur in close proximity to recessions. Roughly nine out of the 11 recessions after World War II coincided with major oil price shocks. But at the same time, the structure of the U.S. economy has changed materially over the past decade with the advent of shale oil.

You now have a meaningful offset from high oil prices, which are crimping U.S. consumers, through investment into the oil industry, net exports, and meaningful production. The U.S. has record-high energy production, is a net exporter of petroleum and refined products, and is a net exporter of natural gas. As a result, the U.S. economy is more insulated from an oil price shock of this magnitude than it was 20 or 30 years ago.

All that said, we did modestly downgrade our growth forecast, moving from 2.4% growth for the U.S. economy this year to 2.3%. We see the oil price shock subtracting about 0.2 percentage points from growth, but we continue to see a constructive outlook for the U.S. economy. Fiscal policy is supportive. Monetary policy is supportive. Financial conditions are adding materially to growth, and there is an underlying secular trend of significant investment in AI, all of which leaves us with a relatively resilient growth outlook.

Learner: Matt, we’ve seen oil prices come down in recent days. At what level would oil prices materially threaten the broader health of the economy?

Luzzetti: One factor helping keep the U.S. economy resilient is that consumers are benefiting significantly from tax cuts that were legislated last year. The One Big Beautiful Bill had a material cut to tax rates, most of which in the peak amount is being felt this year. CBO suggests that it adds roughly $250 billion to household income this year, which creates a meaningful buffer against oil price shocks. However, if oil prices moved toward $150 per barrel on Brent crude and stayed there for an extended period, I would become much more concerned about the U.S. consumer. You would absorb that tax buffer that they have from tax cuts. That’s an environment where I’d be worried about nonlinear dynamics around oil prices, where household incomes would take a hit, consumer spending would potentially take a hit. The potential of that could spill over into layoffs and a weaker labor market. Importantly, we’re not near those levels at the moment, but there remains considerable uncertainty about how this exactly would play out, and I think it’s important to have those types of levels in mind when you’re thinking about a more negative effect on the U.S. economy.

Bentsen: Let’s stay on the topic of inflation. The oil situation has added pressure to inflation, which was already above the Fed’s target. You’ve removed your expected 2026 rate cut. What’s changed, and are you now more concerned about inflation than weak growth?

Luzzetti: Coming into the year, we had one rate cut penciled in in September. And the story that we had in mind was that there’d be enough progress on disinflation in the back half of the year. We initially had seen core PCE inflation. The Fed targets PCE inflation rather than CPI. And we saw core PCE coming down to about 2.4% by the end of this year. Not all the way back to 2%, but meaningful progress being made. We thought that plus the potential turnover in Fed leadership in a more dovish direction could allow for a rate cut this year. We no longer see that as being a base case for a few reasons. The most important is on the inflation front. We have revised up our inflation forecast for core PCE from 2.4% up to 2.9%. So we see core PCE inflation remaining about a percentage point above the Fed’s 2% target. And it’s important to note that a lot of that is simply higher inflation so far this year than we were already anticipating. We don’t build in all that much more upside from the oil price shock because there’s a lot of the research out there, including the one that we’ve conducted, suggests that there’s not too much pass-through from oil price shocks into core inflation in the US beyond items such as airfares.

But with inflation now not making any material progress on the Fed’s objective, with the labor market to us looking like it’s stabilizing and us getting greater confidence around that outcome, and with a Fed facing this reality in an environment where Chair Powell looks like he’s going to stay on the Board of Governors for a period of time, the rest of the committee has shifted in a more hawkish direction. We saw three dissents in a hawkish direction to last week’s statement. All of that leaves us no longer expecting the Fed to cut rates this year.

Bentsen: And you mentioned PCE, you mentioned with the oil price shock or increase having some translation into core PCE. But what are the other pressures that you’re seeing that are keeping that elevated?

Luzzetti: So we would expect some translation and transmission into core PCE in some items. So airfares is a very clear example. Those did spike higher in the March CPI data. We get another CPI reading next week. I would expect that again, you get another strong airfares print. But outside of that, the US economy is predominantly services oriented. And so oil price shocks and energy price shocks have to go through multiple layers to ultimately feed through into inflationary pressures. There’s been a lot of research done at the Fed. The Fed’s workhorse models for the US economy show very limited pass-through for the US from oil prices to core inflation. That’s something that’s different than other economies in Europe and the UK. You see more significant pass-through, and it’s probably a reason why those central banks are actively thinking about hiking rates at this point, while the Fed is more so just thinking about keeping rates on hold.

In terms of what’s keeping inflation elevated, tariffs have been an important part of the story. The Fed believes that tariffs have lifted inflation by 0.5 to 0.75 percentage points. But beyond that, services inflation has remained elevated. Healthcare inflation is elevated. There’s a multiple of reasons and factors behind it. It’s not just one thing. And part of it is demand has remained relatively resilient. We’ve had a series of supply-side shocks, including tariffs, all of which is keeping inflation about a percentage point above the Fed’s target.

Learner: Matt, Fed Chair Powell recently noted that nobody is calling for a hike right now, and you mentioned that you already dialed back your rate view for the year. What would need to change in the data for cuts to come back into your base case?

Luzzetti: So I think the Fed is a dual mandate central bank. They look at both the labor market side of their dual mandate and the inflation side. And now this year, I do not see an inflation-only path for rate cuts. Some people, these good news rate cuts, the Fed is able to cut simply because inflation is coming down. That path seems to have evaporated given the inflation data that we see at the moment. I think that leaves us with most likely only bad news paths to rate cuts, and that means that the economy has weakened, growth is weaker, the labor market is softer, and that the unemployment rate has risen. So it’s not our base case, but if you were to see the unemployment rate rising noticeably above 4.5%, today, we’re a day ahead of the April jobs report. It’s currently 4.26%. But if the unemployment rate were to rise noticeably above 4.5%, I think that’s an environment where the Fed could begin to consider rate cuts again. But again, those are kind of bad news, so to speak, rate cuts triggered by a weakening economy rather than good news rate cuts triggered by softer inflationary pressures.

Bentsen: So let’s turn to rates more broadly, because we have seen a lot of movement there. We’ve seen a notable rise in the 10-year treasury yields, almost 50 basis points over the last six months. What’s driving that, and how much of that is tied to fiscal dynamics or supply?

Luzzetti: Yeah. It’s somewhat difficult to disentangle the forces and factors that are behind this. But one very important factor has been the reassessment of the Fed outlook. As you were coming into this period and episode, markets were pricing material Fed rate cuts over time. The market is now pricing a very flat Fed path over the next year, with more balanced risks around rate hikes and rate cuts. And that’s been an important driver of a reassessment of the curve, even out to longer duration.

In addition to that, you’ve had some pressures that tend to put upward pressure on. You’ve also seen a notable rise in real yields, particularly out the curve, and real measures of term premia. Oftentimes, that is associated with fiscal dynamics, with a buildup in debt loads. I think, importantly, this is not happening just in the US. This oil price shock is pushing many economies to think about supporting their own domestic economy through fiscal policies. And so I think the market is looking at a reality in which budget deficits are likely to be higher than what they were anticipating. Government debt issuance is likely to be higher than they were anticipating. And in that environment, markets require more term premia, more risk premia in order to compensate for those risks.

Bentsen: So with debt held by the public now exceeding 100% of US GDP, notwithstanding the fact, I think, that the US economy, I believe, has the capacity to manage a heavy debt load. But at some point, that will matter to markets. Are we starting to see that now? Are we starting to see the so-called bond vigilantes gathering around the US Treasury market?

Luzzetti: I think it’s first off important to note that I don’t think that there is any tipping point that we know ex ante, meaning once you get to 100% debt to GDP, those bond vigilantes come out and lead to some type of spiral in which yields rise. There is no such tipping point as you look across economies. The greatest example is Japan, where they are holding more than 200% of debt to GDP with very low interest rates. Now, they are a very specific and unique example, where most of their debt is held domestically. They don’t have to go to foreign lenders. And therefore, they’re willing to accept lower interest rates. That is not the case for the US. The US does rely on foreign investors significantly. And so, you might want to think about it somewhat differently.

At the same time, the US does have a significant or exorbitant privilege from being the world’s reserve currency. And it does look to us like US yields, 10-year yields, are probably about a percentage point lower than they would be given the US debt dynamics, given that reserve currency status.

Now to the question of when do bond vigilantes, when does this become the primary story that dominates markets? It is always hard to know ahead of time. I think what we’ve seen is episodically, it has been the dominant factor in markets. If you go back to 2023, during the summer and fall, you had seen during that period long-end yields were rising up towards 5%. Everybody was talking about US debt issuance, the fact that that was running ahead of expectations. And foreign investors, US investors were demanding greater premium. But we also learned during that period, it didn’t take much from a policymaker perspective to quell all those fears. The Yellen-led Treasury reduced issuance at the long end, or didn’t increase it as much as anticipated. The Fed shifted in a more dovish direction. And global investors willing to buy long-end US paper at 5%, they were quite happy to do that. And so I think what we learned from that is a few things you need to see. One, the Fed can’t be dovish. As long as the Fed is thinking about cutting rates, people are willing to buy long-end yields. Two, you probably need some inflationary dynamics that worry markets. And three, it needs to be a global phenomenon. Interest rates need to be rising globally.

Those conditions very well could be in play as we look ahead, but ex ante, it’s hard to know exactly when that will be the key factor for markets.

Bentsen: You brushed a little bit on fiscal policy, and another component of fiscal policy is as the debt—well, one is the debt gets larger, and two is if and as rates increase, the cost of servicing the debt becomes a fiscal policy issue. Today, interest expense on the debt’s about 14% of US government spending. How much are you concerned with the rising cost of servicing the debt?

Luzzetti: Look, I think it is a concern as you look ahead. Another metric there is that net interest costs are more than defense spending at this point. And so it is a substantial portion of the debt. And as you look ahead, according to the CBO’s projections and our own, this share continues to rise ever further as you look ahead. And it’s not just because interest rates are more elevated, but it’s also because the debt load is more significant. I think the key concern from a US debt perspective is that the key drivers of spending are all politically very difficult items as we look ahead. Net interest cost is one of them. Healthcare costs, Social Security benefits. All of these are items where they’re very difficult political problems to solve. It does not seem like there’s political initiatives at the moment to solve them. And therefore, I think it means that those items will continue to grow as a share of overall spending until, if we go back to our previous conversation, potentially bond vigilantes come out and force some consolidation from the US government.

Bentsen: So let’s shift gears a little bit. Again, not unrelated, because this has certainly been discussed in many facets, but also impact on the domestic economy, productivity, but also employment or unemployment, and that’s AI. You recently published research that used AI, or artificial intelligence itself, to assess the potential negative effects of AI on unemployment. What did AI conclude in its report that you published?

Luzzetti: So I think that this was maybe a unique way to use AI, but essentially what we did was go across the different AI platforms and ask them for their own assessment of the probability distribution around how unemployment will be impacted by AI over time.

I think jokingly, a number of people came back and said, “Yeah, of course, if you ask how is it going to come out, is it going to destroy US labor market?” It’s going to say no. But I think that’s important for, as an economist, to not just take what AI is giving you, but to critically assess it. Does it make sense? Are the arguments rigorous and valid? And in this case, I think it is. And so what it found is over the next year at least, it is very unlikely that AI materially raises the unemployment rate. And in fact, it’s probably more likely that it’s a positive force for the labor market than a negative force. And I think we see that in certain items. AI is a significant driver of investment demand in the US. You have a big data center build-out, which is lifting non-residential structures and non-residential employment. And so in the near term at least, I would view the rest as being quite balanced, if not somewhat supportive of AI being a positive force for the labor market.

As you go further beyond that, I think it’s a far more open question. You do have a US economy that is significantly exposed to potential replacement from AI. As you look across the academic literature, there’s probably anywhere from 10% to 40% of occupations that are exposed to AI over time. So it’s somewhat easier to quantify the negative effects. What is unknowable is new jobs that will be created by AI as we look ahead. And that is typically the positive force from technological innovations. There was one data point mentioned by Lisa Cook, Governor Lisa Cook recently, based on research from David Alter, which basically highlighted that 60% of jobs today were not in existence in 1940. And that just, I think gives you the sense of which it’s hard to know the positive side of innovations, and of innovations that are as dramatic as AI. We’re probably more able to quantify the downsides.

Bentsen: And your work published in March suggested that AI may not be as disinflationary as many expect. What’s driving that view?

Luzzetti: This was triggered by conversations that I was having with clients really up until the war in Iran, and they were all focused on the idea that AI was going to be this substantial disinflationary force that over time was going to allow the Fed cut rates materially and was causing investors to put bets on Fed rate cuts prior to this period where you then had a big jump in oil prices. I think similar to the work on the unemployment rate, it leads to somewhat conflicting results in the sense that in the near term at least, AI looks like it could be an inflationary force. And we actually see this within the data. If you look at software inflation, it is taking off significantly within PC inflation data. The inflation rates for things like computer and peripheral equipment are taking off significantly, and this is all because you have a massive boom in demand for these items from businesses across the spectrum. Which is kind of crowding out the investment and the spending for consumers and lifting those inflationary pressures. So, that plus energy and electricity costs, I think in the near term at least lead to AI being a positive source for inflation rather than a drag on the inflation environment.

Bentsen: Just to follow up on that, though, would that be assuming all the productivity promises and others that are suggested of it, that short-term investment boom which has some inflationary pressure, would that flatten out over the long term though, in your opinion?

Luzzetti: I think it’s a timing question. I think in the moment, we are in an environment where you have massive amounts of investment demand for AI, which is driving prices higher and can be an inflationary impulse. And we are at the very early stages of reaping the productivity benefits from AI. I believe that we will reap those benefits, but we’re at the very early stages of that. And so while in the near term at least, it is more likely to be an inflationary impulse than a disinflationary impulse. As we look ahead, I do agree that productivity will be stronger, and it will put downward pressure on inflation as we look ahead.

Learner: Matt, what are your views in terms of AI leading to an increase in productivity over the long term?

Luzzetti: 

I think as a starting point, we’re already in what you might think of as a productivity boom. We have kind of the most sustained strength and productivity we’ve really seen since the mid to late 1990s. My own view on our own research has suggested that is really just the knock-on effects from a historically tight labor market in 2021 and 2022. The idea is that that tight labor market, the scarcity of labor, and how expensive labor was, incentivized firms to do investment, to do innovation, to gain productivity gains, and that’s now paying benefits. We’re at the very early stages of AI-driven productivity gains. You can see some of it showing up in the data. So for example, there’s a positive relationship between AI adoption rates and productivity growth across different sectors. There’s also a positive relationship between AI adoption rates and new business formation across sectors. So I think we’re beginning to see the early evidence of that.

We build in about 0.5% to 0.75% boost to productivity growth from AI as you look ahead. I view that as the midpoint of the range that comes out of academic estimates. Just to give you a sense of how wide the potential scope or spectrum is here. Academic estimates go from probably about zero benefit of productivity growth from AI to as much as 1.75 percentage points per year impact from productivity growth. That probably spans the spectrum of the likely outcomes, and we might be a little bit conservative in taking the central tendency of that range.

Learner: And what’s the timeline for that? When can we expect to see that kind of steady state impact to growth?

Luzzetti: The Census Bureau has great data about AI adoption across firms. And across sectors and states, AI adoption rates are really below 50% across most sectors and states at this point in time. It’s still quite early in the AI adoption. And when you ask firms, how are they using it, some of it is productivity enhancing. Some of it, a much smaller share, is actually labor substituting. But I think in a lot of areas now, it’s simply starting the process of learning how AI can help to boost productivity gains as we look ahead. So I think for this year, you’re unlikely to see substantial productivity gains coming from it. I think given the rapid pace of progress in this sector, it is really hard to benchmark exactly when we will see those gains. But it would not be surprising to see material productivity gains coming from AI next year.

Bentsen: So maybe let’s close with what our audience should watch for this month. Market performance, especially equities, has been relatively sanguine, despite macro instability. What do you think is driving that?

Luzzetti: So my colleague, Bankim Chadha, who’s our global equity strategist, has one really compelling chart on this, which shows that across historical geopolitical events, the market typically recovers all of its losses within six weeks. The average is that the market goes down about three weeks and then recovers over the final three weeks. This period looked to be a little bit different. It took about four weeks to reach the bottom and then two weeks to recover. But the broad recovery in the market was very consistent with what you typically see in response to geopolitical events. And it tells you that markets internalize those risks relatively quickly, and need further and even more escalation to continue to trade downward. The second key element here is that earnings have been actually very strong. We’re kind of in the midst of Q1 earnings, and again, I would refer to Bankim Chadha’s peer. But we’re looking at maybe close to 25% earnings growth. You see breadth in earnings growth. All 11 sectors are adding. The median firm is in double-digit earnings growth. And so we’ve had also a material earnings growth positive surprise that has taken place. Certainly partly driven by AI, but there is breadth behind it as well. I think those two factors support the quick recovery that we’ve seen.

Bentsen: And what, if anything, is keeping you up at night? You mentioned $150 Brent crude, but obviously we’re a long ways away from that. But we’re a long ways away from $60 Brent crude, where we were at beginning of the year last year. Are there things out there you’re thinking about that could be disrupted?

Luzzetti: I think one thing that we’ve learned over the past five or six years is that there’s plenty of things to keep us up at night. Oil prices, geopolitical risks are certainly one of them as I think about the US economy. Despite what I outlined as a very constructive outlook for the labor market, there still is this uncomfortable equilibrium between low hiring and low firing that is taking place. And you worry about that that could break at some point. Again, not our base case, but you do worry about that. As you look ahead, AI is going to be a very positive force, I think, in many ways. But at the same time, it’s going to be a very disruptive force, and it’s hard to benchmark exactly how that will play out. And so, a lot of our time is spent in thinking on exactly how that will work its way out and play out. And then finally, two items, one of which we talked about here, thinking about the US debt situation and when do bond vigilantes come back. And the final one, which is not behind us yet, is threats to Fed independence, and potentially what that could mean for markets as well. All of these, I think, are reasons to be up a little bit at night, at least.

Bentsen: And Heidi, from your perspective, as head of our research at SIFMA, what about you? What are you looking at?

Learner: I’ve been looking at equity volatility, and in particular, intraday volatility. One thing I did is looked at the difference between the high in the S&P for the day and the low for the day, and looking at that as a percentage of the prior day’s close. And year to date, we’ve had more than half of the trading days show a greater than 1% swing. So again, looking high minus low for the day as a percentage of the prior day’s close. So that equity volatility is keeping a lot of people glued to their screens. So it is something that I continue to monitor.

Bentsen: Well, Matt, Heidi, thank you all very much for your insights today. Really great conversation. And I also want to thank all of our listeners for joining us as well. To learn more about SIFMA and our work to promote effective and resilient markets, please visit sifma.org. And we’ll look forward to seeing all our listeners and viewers in June for our next “Market Snapshot.”