Dow Sheds 653 Points as Oil Tops $100 Ahead of This Week's Fed Decision

Supply Shock

A supply shock is a sudden change in the availability or cost of a key input, such as oil, that shifts prices across the economy regardless of how much demand there is. A negative supply shock, like an oil price spike from a Middle East conflict, raises costs for transport, manufacturing and consumers at the same time, pushing inflation up while slowing growth. This is what makes supply shocks hard for central banks. A demand-driven inflation problem can be fought by raising rates, which cools spending. A supply shock leaves the Fed choosing between two bad options: tighten and deepen the growth slowdown, or look through the price spike and risk letting higher inflation expectations take hold. Many central banks lean toward looking through temporary shocks, but only if long-term inflation expectations stay anchored. Markets reveal which view is winning through the sectors and the yield curve. Energy stocks gain while consumer-facing and rate-sensitive sectors lag, and traders reprice the odds of future rate hikes.