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Plunging Oil Price May Halt Fed's Plans

By Michael KramerMarket OverviewDec 03, 2021 05:34AM ET
www.investing.com/analysis/plunging-oil-may-halt-feds-plans-200610337
Plunging Oil Price May Halt Fed's Plans
By Michael Kramer   |  Dec 03, 2021 05:34AM ET
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This article was written exclusively for Investing.com

Wouldn’t it be ironic if, at the exact moment that the Fed threw up its hands and capitulated on its transitory inflation narrative, inflation came crumbling down?

Inflation might be ready to take a turn lower, and it could show up as early as the November data release. 

One of the most highly correlated components of the consumer price index (CPI) and the producer price index (PPI) is oil, and oil has plunged by about 20% since Nov. 10. Gasoline prices have also slid and are down over 22%.

These two commodities have been strongly correlated with the PPI and CPI over many years. Typically, inflation rates have substantial swings when these commodities have significant moves. 

YoY Change In CPI, Oil, Gasoline
YoY Change In CPI, Oil, Gasoline

Over the last 20-years, the one-year change in the CPI and oil correlate at 0.76, a very high reading (1 is perfect), and over 10 years, the correlation rises to roughly 0.83. So the odds would indicate that a move lower in oil prices should reproduce a move lower in the year-over-year change in CPI.

The correlation is stronger for gasoline, at 0.81 over the past 20 years and 0.87 over the past 10 years.  

YoY Change In PPI, Oil, Gasoline
YoY Change In PPI, Oil, Gasoline

This change in oil and gasoline prices also appear to be weighing on 10-year breakeven inflation rates, which have also fallen about 25 bps just since Nov. 15.

More importantly, the yield curve has fallen dramatically over the past several weeks, as the front end of the curve rises and the backend falls. It has resulted in the 10-2 year Treasury Yield Spread falling to around 85 bps, while the 30-year minus the 5-year has fallen to approximately 65 bps. It is potentially signaling a reversal in inflation and slower economic growth.  

Change In Yield Spread
Change In Yield Spread

If inflation were to take a nasty turn and start decelerating at a rapid pace, it would create a whole new set of issues for the Fed. At the same time as the market is starting to worry about slowing growth because the Fed is tightening financial conditions by cutting back on its asset purchases.

The stock market could very quickly and forcefully start pushing back on the Fed’s ambitions to taper, creating a big mess in the process. 

Of course, that would be the irony in all of this. The Fed has had the stance for a very long time that inflation would be transitory and that rates would moderate back to their historical trends. But then it changes its stance, just as the dynamics and macro backdrop have changed and shown evidence of potential easing in some of the most significant contributors to inflation. 

At the same time, the risk would be increasing that the Fed would have to reverse its plans to taper at all. Much of the inflation we have seen has come through supply constraints. But a lot of it has also come from sharp declines in many critical commodities in 2020, followed by a swift rebound, which overstates those rates. 

It would be just ironic that at the exact moment in time when the Fed backs away from transitory inflation, inflation turns out to be, well, transitory. 

I guess stranger things could happen.

Plunging Oil Price May Halt Fed's Plans
 

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Plunging Oil Price May Halt Fed's Plans

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Comments (16)
my name
my name Dec 04, 2021 5:35PM ET
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1. Oil market is NOT FREE MARKET! 2. Inflation is ETERNAL!
Casino Crypt
CasinoCrypt Dec 04, 2021 10:36AM ET
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People get trapped into believing what the Fed says . The Fed is talking to the Treasury audience 80% of the time which is established under the incumbent administration .  401K s are therefore influenced so the fundamentals are never really dissected or really questioned by main stream press - all questions are softball .Elizabeth Warren seems to be the only person I know who understand the markets.( Futures , Bond and equity ) . Therefore the Fed knew all long that real tapering and lift off for Interest rates was never going to happen. But they have to dance the tune for the equity market audience but the fundamentals are rock solid . When an individual keeps repeating a promise and never executes then you know they don't believe what they say. The fact that  Powell ( never mentioned ) the tapering of mortgage back securities means full broad taper was never going to happen.  The elephant in the room every day is the purchasing of mortgage backed securities. He side steps this.
William Bailey
William Bailey Dec 03, 2021 11:08PM ET
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Garbage … of course deflation has started , but the fed aint gonna print more free cash for the wealthy
Nkechi Christian
Nkechi Christian Dec 03, 2021 4:28PM ET
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you need oil I can give you any quantity you desire
simeony sinco
simeony sinco Dec 03, 2021 4:28PM ET
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ok I need it
Jan Buyle
Jan Buyle Dec 03, 2021 1:14PM ET
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So, you believe inflation is caused by the rising price of oil? It is not. It is caused by unlimited money printing, taking the real value ( = buying power) of every dollar down. This is basic economics...
Patrick Tse
Patrick Tse Dec 03, 2021 1:14PM ET
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oil prices has a direct correlation with transportation costs in the supply chain
William Bailey
William Bailey Dec 03, 2021 1:14PM ET
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Mostky . Oil falling as consumers fall off .. opec not even selling yet
Rob Stamp
Rob Stamp Dec 03, 2021 1:14PM ET
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The author isn't stating that oil costs cause inflation. He's stating that oil & gas commodity pricing have a strong correlation to the direction of inflation
Shep De
Shep De Dec 03, 2021 8:41AM ET
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Excellent commentary, it's certainly an interesting paradox. Something's got to give, both could give too. Yes, gas prices down in westernWA state, were 3.63 regular and now 3.49 , but oil has gone up 4-5% the last 2 days too. Over $75 crude WTI my inflation alerts go onSo hard to tally really!
john sara
john sara Dec 03, 2021 8:14AM ET
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The FED has no plan; the markets are and have been entirely in charge of the FED There is no policy other than further debasing of the dollar and fiat currencies in general. The operate continually in fear, as a reactive force at best; that fear being that if they do not continually bail out the elite that the super rich will crash the economy.
Darren Eade
Darren Eade Dec 03, 2021 7:57AM ET
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Whoever thinks prices are heading down and inflation is just going to disappear is literally on another planet!
Dave Kluchinski
Dave Kluchinski Dec 03, 2021 7:37AM ET
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Not sure where u get gas prices are down 22%. In NJ they are down 4 cents since Oct????
Mark McMillan
Mark McMillan Dec 03, 2021 7:31AM ET
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oil popping right back up after omicron manipulation.
 
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