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Oil prices and breakeven inflation rates revisited

In an earlier FRED Blog post, we highlighted the simultaneous decline in the 5-year breakeven inflation rate and the price of oil in 2014. (The 5-year breakeven inflation rates are obtained from 5-year Treasury inflation-indexed constant maturity securities and are thought to represent the market’s expectation of CPI at a 5-year horizon.) At that time, we argued that markets might have believed that the drop in oil prices reflected a slowing in global demand that might result in a persistent decline in consumer prices. In this post, we make a longer comparison—from 2011 to 2019—between the same two series shown in the original graph.

The graph above shows that the correlation between the breakeven inflation rate and oil prices is not limited to the steep decline that occurred in 2014. Indeed, the correlation between the two series over the entire period shown (January 2011 through March 2019) is 0.65. Prior to 2015, the two series appear to occasionally move together. The comovement was particularly obvious when the two series exhibited large changes, rising together in early 2011, falling together in late 2011, etc. From January 2011 to January 2015, the correlation between the series was 0.49. From January 2015 to March 2019, the correlation between the two series became even more apparent, rising to 0.85.

A few academic papers have tried to analyze the cause of the comovement, but the high degree of correlation between the two series remains puzzling. Even if changes in oil prices pass through to consumer prices, one wouldn’t expect such a close correspondence between oil prices today and consumer prices at a 5-year horizon.

How this graph was made: Search for “crude oil prices,” select the series “Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma” with a daily frequency,  and click “Add to Graph.” From the “Edit Graph” panel, select the “Add Line” option: Search for “5-year breakeven inflation,” select the first series shown (“5-Year Breakeven Inflation Rate, Daily, Percent, NSA”), and add the data series. In the “Format” tab, change the y-axis position from left to right for the breakeven inflation rate and set the start date to 2011-01-01.

Suggested by Michael Owyang and Hannah Shell.

View on FRED, series used in this post: DCOILWTICO, T5YIE

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