Rising oil prices traditionally boost
inflation expectations and US interest rates. The May futures
contract for light sweet crude oil is up today for the sixth consecutive
session.
It has risen 11 of the past 12 sessions.
Over the past two weeks, oil prices have appreciated by 8.7% and are up almost
2.5% this week already. Yet US yields are languishing. The US 10-year
yield is near four-month lows, and the two-year yield is lower than when the
Fed hiked last December.
US yields have decoupled from oil prices.
Last summer the correlation between the percent change in oil and the percent
change in US 10-year yields on a rolling 60-day basis reached 0.6, which is the
upper end of where it has been since the financial crisis. The
correlation is now inverse for the first time in nearly two years.
The same general pattern holds for the US
two-year note and oil prices. The correlation reached 0.6 last year,
which was a seven-year high. The relationship has broken down, and the
correlation is negative for the first time since the middle of 2015.
Conducting the correlation on the basis of
percent change of a yield, which is a percent itself, may be problematic.
Conducting the correlation on the level of the oil and the yield level does not
alter the picture substantially. Over the past 60-day the correlation of
the price of oil and the two and 10-year yields are -0.58 and -0.26
respectively.
We also looked at the 10-year break-even,
which is the difference between the yield of the inflation-linked security and
conventional yield. The correlation on a percent change basis is
fallen from nearly 0.70 in Q3 16 to near 0.20 now. On a purely
directional basis, the correlation has been more than halved to 0.33 since the
start of the year. This suggests a decoupling of inflation
expectations and the price of oil.
Yesterday’s report suggesting that Saudi
Arabia may be leaning toward extending OPEC output cuts helped extend the
advancing streak in oil. This did not seem very surprising,
though prices firmed. Note that OPEC boosted its estimate for US
shale production by 200k barrels a day to 540k. Non-OPEC output forecast
was lifted for the third consecutive month. It now stands at 580k barrels
a day, more than four times OPEC’s January estimate and roughly half as
much as OPEC intends to cut.
News today suggests Russia may not be so keen
to do so may be behind the light profit-taking after the May contract reached
$53.75, the highest in a month. Over the past several sessions, the
May contract has been hugging the upper Bollinger Band, set two standard
deviations from the 20-day moving average. Other technical indicators are
still constructive. Nearby resistance is seen near $54.00-$54.30.
Support is pegged around $52.80-$53.00.
The US Department of Energy reported today
that oil inventories fell by 2.166 mln barrels last week. This is the
first draw down in four weeks and only the second decline in US oil stocks this
year. This is helping prices recover from the profit-taking seen earlier
and may help the May contract extend its advancing streak. Inventories in
Cushing rose but by less than expected. Gasoline and distillate
inventories fell. The DOE’s estimate of demand for oil and the
products increased.