U.S. Inflation Market Jumps on Prospect of Tighter Oil Supply

(Bloomberg) -- The prospect of another move by the U.S. to quash Iran’s oil exports fired up U.S. inflation markets Monday.

A jump in West Texas crude oil prices to a nearly six-month peak just under $66 a barrel helped push market-implied expected inflation over the next five years to 1.89 percent in U.S. trading. That’s the highest level for the five-year breakeven rate in a month. Oil surged as U.S. President Donald Trump’s administration said it won’t renew waivers of sanctions against countries importing Iranian oil.

U.S. Inflation Market Jumps on Prospect of Tighter Oil Supply

Breakeven rates widened as yields on Treasury inflation-protected securities, or TIPS, declined relative to yields on ordinary Treasuries. At the five-year point, where a $17 billion new TIPS issue drew a yield of 0.515% at auction on Thursday, the inflation-linked note traded down to 0.481% on Monday, while the nominal five-year yield rose as much as 1.7 basis points.

Oil prices are “certainly supportive” of breakevens, but the sustainability of the move “really depends what happens with the oil market response and whether we get credible announcements from Saudi Arabia and others on replacing any lost oil from Iran,” Barclays rates strategist Michael Pond said.

The prospect of tighter supply in global oil markets is supporting the market’s inflation expectations without much help from domestic price data. The Consumer Price Index for March showed price pressures remain tame, as core inflation -- which excludes volatile food and energy prices -- rose 0.1 percent, less than expected. The Fed’s preferred inflation measure -- the deflator for personal consumption expenditures -- slowed to a pace of 1.4 percent year-on-year in January.

And TIPS breakevens declined last month, after Federal Reserve policy makers cooled toward another rate hike this year, expressing concern about inflation failing to reach their 2 percent target.

The current dovish set-up makes a good case for betting on a further increase in the five-year breakeven, according to UBS global rates strategist Chirag Mirani. He recommends positioning in inflation-linked bonds to benefit from rising Treasury yields over the rest of the month.

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