Oil prices have jumped significantly since the drone attack on Saudi oil facilities. But markets are so far taking a sanguine view of the moves and appear to be pricing the spike as temporary. Here are three other points to note:
1. US inflation expectations have picked up, but have been lagging behind oil moves for a while now. If we look at US inflation-linked bonds markets, we find that implied inflation expectations do generally move with oil prices. However, since June they have been lagging behind the moves higher in oil prices. This is still the case with the oil surge (see chart). The Fed will be heartened by this and will likely look past the inflationary impact of higher oil. Instead, they will focus on the negative growth implications and so tomorrow’s expected 25bps will probably be realized.
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Oil prices have jumped significantly since the drone attack on Saudi oil facilities. But markets are so far taking a sanguine view of the moves and appear to be pricing the spike as temporary. Here are three other points to note:
1. US inflation expectations have picked up, but have been lagging behind oil moves for a while now. If we look at US inflation-linked bonds markets, we find that implied inflation expectations do generally move with oil prices. However, since June they have been lagging behind the moves higher in oil prices. This is still the case with the oil surge (see chart). The Fed will be heartened by this and will likely look past the inflationary impact of higher oil. Instead, they will focus on the negative growth implications and so tomorrow’s expected 25bps will probably be realized.
Chart 1: Inflation Bond Markets Have Been Lagging Oil Markets
2. China is the world’s largest oil importer and, unlike the US, does not have booming domestic oil industry. Recent real economy data – whether investment, retails sales, or industrial production – has been weak. The oil spike, then, comes at a vulnerable time for China. The Chinese numbers that are starting to increase are the credit numbers. Last week’s data showed money supply and new yuan loan data increasing. This comes after announcements of RRR cuts by the PBoC. We should expect more credit easing and perhaps even more conciliatory trade talks – at least from the Chinese side.
3. No more US as global policeman. One of the notable features of President Trump’s foreign policy has been to shift security issues back to regional powers. For example, he has demanded that Europeans build up their military to fend off threats rather than rely on the US, and has castigated past US administrations for expensive military adventures abroad. The direct attack on a US ally, Saudi Arabia, is an important test of this thesis. So far, the President appears to be reluctant to start a war with Iran. Part of this could be related to increasing hostility towards Saudi by parts of Congress in relation to the death of journalist Jamal Khashoggi and the Yemen war. But part could also be related to the President’s view on regional powers fixing their own problems. The next few days will be important to test this view.