Crude Oil & Breakeven Inflation: What Gives?
The Fed meeting will come and go this week. As the committee debates whether to hike rates one more time at its November 1 gathering, commodities appear to be putting upward pressure on headline inflation – potentially throwing a wrench into the whole immaculate disinflation narrative.
Indeed, the Goldilocks soft landing story became consensus in Q3, but traders are no doubt hearing more sellside calls for an eventual dip in real GDP growth. Does that come in Q4, care of higher commodity costs, cycle-highs in rates across the belly of the curve, and a steeply higher US Dollar in the past two months? Will the United Auto Workers (UAW) strike, along with student loan repayments, affect how the FOMC conducts policy? Big questions. Lots of unknowns.
We as traders can cut through some of this noise, though. Charts and price action are the best arbiters as to what variables matter and which simply make for snappy newsletter headlines. With the Fed meeting this week, one key chart caught my eye. Well, it’s two indicators on one set of axes.
First, what are we looking at here? It’s the 10-year breakeven inflation rate (the yield difference between the 10-year Treasury note and comparable-term TIPS) and the rolling continuous prompt-month of WTI crude oil. Usually these two lines move together, but that hasn’t exactly been the case in the last few months. While WTI surged from the mid-$60s to the low $90s, a more than 35% rise, inflation expectations, as dictated by price, have barely budged.
It tells me that the disinflation story is still true. Also, perhaps market participants even feel as if the Fed is going too far with its tightening cycle – where would inflation expectations be if crude were still near $70? This is a chart I’ll be keeping my eye on this week through year-end to monitor where bond traders effectively see the inflation rate going.
Indeed, the Goldilocks soft landing story became consensus in Q3, but traders are no doubt hearing more sellside calls for an eventual dip in real GDP growth. Does that come in Q4, care of higher commodity costs, cycle-highs in rates across the belly of the curve, and a steeply higher US Dollar in the past two months? Will the United Auto Workers (UAW) strike, along with student loan repayments, affect how the FOMC conducts policy? Big questions. Lots of unknowns.
We as traders can cut through some of this noise, though. Charts and price action are the best arbiters as to what variables matter and which simply make for snappy newsletter headlines. With the Fed meeting this week, one key chart caught my eye. Well, it’s two indicators on one set of axes.
First, what are we looking at here? It’s the 10-year breakeven inflation rate (the yield difference between the 10-year Treasury note and comparable-term TIPS) and the rolling continuous prompt-month of WTI crude oil. Usually these two lines move together, but that hasn’t exactly been the case in the last few months. While WTI surged from the mid-$60s to the low $90s, a more than 35% rise, inflation expectations, as dictated by price, have barely budged.
It tells me that the disinflation story is still true. Also, perhaps market participants even feel as if the Fed is going too far with its tightening cycle – where would inflation expectations be if crude were still near $70? This is a chart I’ll be keeping my eye on this week through year-end to monitor where bond traders effectively see the inflation rate going.