Thursday, October 15, 2009

Oil hits new high, bond yields lag

For most of the past year, there has been a very strong correlation between T-bond yields and crude oil prices, as this Bloomberg study shows. In the past month, however, bond yields have lagged the rise in crude prices. Crude has now reached a new high for the year, while bond yields  are 50 bps below their highs for the year, which occurred about four months ago.

On the margin, however, over the past few weeks the modest rise in T-bond yields has been driven almost exclusively by rising inflation concerns; TIPS real yields have been flat while nominal yields have risen, with the result that the breakeven inflation rate has risen. This makes sense, since higher oil prices are quite likely to result in higher consumer price inflation in coming months.

It would appear to me that bond yields have some catching up to do with oil prices.

Full disclosure: I am long TBT at the time of this writing.


ronrasch said...

Scott, would you be concerned about a market decline if treasury bond yields continued to go down and the dollar went up? Would this relationship indicate a flight to safe treasuries to avoid stocks because of US out of control spending?

Scott Grannis said...

Well, if you asked me to predict what the stock market would do given declining bond yields and a rising dollar, I would guess that the market would be falling. Lower yields and a stronger dollar would be symptomatic of a shortage of money and/or rising money demand that is not offset by monetary policy ease. Treasury yields lower than we have today would also be symptomatic of a market that had a very dim view of the economy's growth prospects. So I think that would be consistent with a declining stock market.

As you know, I have been generally a cheerleader for rising bond yields, so I am being consistent with my framework for analysis.