Lionel Melin

Lionel Melin

Senior Cross-Asset strategist


Inflation (Part 1): Oil Base Effects to Lift US Prints, Breakevens Look Cheap

27 May 2016

Active Strategies

Our model highlights that a consolidation of WTI at $45 per barrel should pull US headline inflation beyond 2.2% yoy over the next 12M.

  • Strong WTI base effects expected in H2 2016 (from the 2-stage slump since summer 2015, to the recent recovery).
  • The CPI Energy segment tightly reflects oil costs (with 1M lag and a beta of 1/3) so that its marked bounce back should drive CPI headline higher.
  • A $10 change on the WTI profile adds (or withdraws) 50bps to US inflation.

We assume a conservative 2% core CPI inflation.

  • We consider four classes of structural drivers: business and credit cycle, FX pass-through, and real estate conditions.
  • The first two are hardly headwinds any more. Surprisingly, we find FX effects not statistically significant. Conversely, rental costs (40% share of core CPI) buoyed by house prices, should remain a major driver.
  • Our model of core CPI points toward a 2.1% growth, 10bps lower than the CBO forecast.

According to our analysis, US breakevens appear to price a scenario where the barrel would slide back to $35. We believe this scenario to be unlikely and recommend taking a long position on inflation sensitive instruments.

 


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