Decoupling of Oil and US Interest Rates

Rising oil prices traditionally boost inflation expectations and US interest rates.   The May futures contract for light sweet crude oil is up today for the sixth consecutive session.  

It has risen 11 of the past 12 sessions. Over the past two weeks, oil prices have appreciated by 8.7% and are up almost 2.5% this week already.  Yet US yields are languishing. The US 10-year yield is near four-month lows, and the two-year yield is lower than when the Fed hiked last December.  

US yields have decoupled from oil prices.  Last summer the correlation between the percent change in oil and the percent change in US 10-year yields on a rolling 60-day basis reached 0.6, which is the upper end of where it has been since the financial crisis.  The correlation is now inverse for the first time in nearly two years.  

The same general pattern holds for the US two-year note and oil prices.  The correlation reached 0.6 last year, which was a seven-year high.  The relationship has broken down, and the correlation is negative for the first time since the middle of 2015. 

Conducting the correlation on the basis of percent change of a yield, which is a percent itself, may be problematic.  Conducting the correlation on the level of the oil and the yield level does not alter the picture substantially.  Over the past 60-day the correlation of the price of oil and the two and 10-year yields are -0.58 and -0.26 respectively.  

We also looked at the 10-year break-even, which is the difference between the yield of the inflation-linked security and conventional yield.  The correlation on a percent change basis is fallen from nearly 0.70 in Q3 16 to near 0.20 now.   On a purely directional basis, the correlation has been more than halved to 0.33 since the start of the year.    This suggests a decoupling of inflation expectations and the price of oil.  

Yesterday's report suggesting that Saudi Arabia may be leaning toward extending OPEC output cuts helped extend the advancing streak in oil.   This did not seem very surprising, though prices firmed.    Note that OPEC boosted its estimate for US shale production by 200k barrels a day to 540k.  Non-OPEC output forecast was lifted for the third consecutive month.  It now stands at 580k barrels a day, more than four times OPEC's January estimate and roughly half as much as OPEC intends to cut.  

News today suggests Russia may not be so keen to do so may be behind the light profit-taking after the May contract reached $53.75, the highest in a month.  Over the past several sessions, the May contract has been hugging the upper Bollinger Band, set two standard deviations from the 20-day moving average.  Other technical indicators are still constructive.  Nearby resistance is seen near $54.00-$54.30.  Support is pegged around $52.80-$53.00. 

The US Department of Energy reported today that oil inventories fell by 2.166 mln barrels last week.  This is the first draw down in four weeks and only the second decline in US oil stocks this year.  This is helping prices recover from the profit-taking seen earlier and may help the May contract extend its advancing streak.  Inventories in Cushing rose but by less than expected.  Gasoline and distillate inventories fell.  The DOE's estimate of demand for oil and the products increased. 

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