Why the crude oil price won't save US Treasuries
Peter Warburton - 29 November 2018
The round trip in crude oil prices back to sub-US$60/barrel will undoubtedly take the wind out of inflationary sails over the next few months. US Treasury breakeven inflation rates have also reacted in a manner consistent with their new-found correlation to the oil price. However, we doubt whether this news will be enough to reverse the bear trend in US bond prices. The psychology of inflation has shifted over the past three years, reinforced by a buoyant labour market, confident consumers and new leadership at the Federal Reserve. And the transfer of ownership of an expanding stock of US Treasury notes from weakened international hands to domestic holders will require yields to move to a premium.
The plunge in the WTI oil price from a peak of US$76/ barrel to US$51/barrel is starting to resemble the beginning of the 2014 oil price collapse, but the context is very different. The US president may have exerted his influence over Saudi Arabia, but this is no guarantee that OPEC will not decide to cut production again next month. Global oil inventories were rising uncontrollably in 2014 but have modestly depleted in 2018. Even September’s higher fuel prices seemed to have little impact on consumer and business demand as global oil consumption hit almost 100m barrels/day. The threshold of demand destruction looks to be further away.
The drop in the WTI price has been associated with less than a 20-basis point reduction in US 10-year inflation breakevens, thus far. The US inflationary narrative is much broader and better established in 2018, as consumer confidence is buoyant, business surveys close in on previous highs and the labour market has finally delivered the much-vaunted wage acceleration. The inflationary psychology has shifted during the past 3 years and with it, the outlook for the Treasury bond market.
Finally, a momentous transfer of ownership of the US treasury note market is underway, even as its supply is projected to rise strongly. Weakening international demand for US Treasury bonds necessitates a rising yield premium to entice new domestic holders to take their place.
Data source: Thomson Reuters Datastream
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