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Posts tagged with: "T5YIE"

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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

Does the market believe the change in oil prices is permanent?

Oil prices fell dramatically in the last half of 2014, from a high of $107.49 on June 13, 2014, to $54.14 on December 30, 2014, and continued to fall into early 2015. During the same period, a measure of 5-year inflation expectations declined in a similar way. The graph shows the unusual correlation between these two series from January 2014 to the present. The red line is the daily 5-year breakeven inflation rate from the beginning of 2014 to the present. (That breakeven inflation rate is computed from the difference between the 5-year Treasury inflation-protected security, or TIPS, and the 5-year Treasury and is a measure of market expectations of future inflation.) The blue line is the daily price of West Texas Intermediate crude oil.

Market expectations of the inflation rate 5 years out held steady for the most part from early 2013 to early 2014. On April 17, 2014, inflation expectations jumped up. After June 2014, oil prices fell precipitously, taking inflation expectations down with them. After January 27, 2015, oil prices stabilized and began to rise. Again, market inflation expectations rose.

While oil prices can pass through and affect other prices, the almost one-to-one movements in the two series seem to be unusual. Pass-through from oil to other prices is incomplete. If the price increase in oil was deemed to be temporary, the 5-year inflation rate would not move in unison with oil prices (little pass-through). In this case, it appears there’s at least some belief that the change in oil prices will persist, as there is substantial pass-through.

How this graph was created: Search for “crude oil prices,” select the series “Crude Oil Prices: West Texas Intermediate (WTI) – Cushing, Oklahoma,” and graph it on a daily frequency. Select the “Add Data Series” option: Search for “5-year breakeven inflation,” select the first series shown (“5-Year Breakeven Inflation Rate, Daily, Percent, NSA”), and add it as a new series. Select the “Edit Data Series 2” tab and change the y-axis position from left to right. Finally, set the start date to 2014-01-01.

Suggested by Michael Owyang and Hannah Shell.

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


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