Three “Data” items today:
#1: WTI crude prices remain strong at $87/barrel, but with all the talk about inflation recently we wondered how that price compares to inflation-adjusted oil prices from past cycles. Here’s the answer:
- Right after the Iraqi invasion of Kuwait in August 1990, oil prices spiked to $40/barrel – a level they had not seen since the 1979 Iranian Revolution.
Adjusting for CPI inflation, that $40 in 1990 is the same as $85 today.
- WTI would not break $40/barrel to the upside again until 2004. During the commodities super cycle of 2007 – 2008, oil prices reached $80 – $140/barrel.
That range, inflation adjusted, would be $108 – $181/barrel today.
- From 2011 – 2014, WTI oscillated around $100/barrel, levels it has not seen since.
In today’s dollars, based on inflation from 2014 to the present, that is $118/barrel.
Takeaway: oil prices are certainly a major contributor to US consumer inflation over the past year, but across cycles that is not the case. At current levels, crude is priced in line (1990) or even cheap (2007 – 2008, 2011 – 2014) to prior normal-to-peak levels. We continue to believe that oil prices can trend higher and still like Energy stocks here.
#2: Recession indicator, Part 1 – the difference between 2- and 10-year Treasury yields. We bring this up because one of the questions at yesterday’s Chair Powell press conference was on the topic. There is a long-held belief – which Powell recognized as at least somewhat valid – that when 2-year yields are higher than 10-year yields the risk of recession is higher than when the opposite is true.
The underlying logic is that 10-years approximate the neutral rate of interest (neither “easy” or “tight” monetary policy) and 2-years reflect the market’s view of near term Fed policy. When 2s are higher than 10s, the market is saying that Fed policy is too tight and that risks causing a recession.
Here is a chart of 10-year yields minus 2-year yields back to 1990. Sure enough, flat or negative spreads (2000, 2006, 2019) appear just before the grey recession bars. It is not a precise fit in terms of timing, and you can get false positives (1998), but you can see why Chair Powell got a question on this.
Takeaway: at present, 10-year yields sit at 1.8 percent and 2-years at 1.2 percent which gives us a 0.6 percentage point buffer before this spread turns negative. Put another way, 10-years at 1.8 percent means the Fed can only raise short rates to those levels without triggering a warning alarm from this indicator (unless 10-year yields rise further in the interim, of course). Fed Funds Futures only put 14 percent odds on that happening by February 2023 (longest dated contract in the CME FedWatch tool).
#3: Recession indicator, Part 2 – the difference between 3-month and 10-year Treasury yields. The idea here is the same as the 2 – 10 year spread, with 3 month paper serving as the proxy for Fed policy. The difference between the two is obviously wider than 2s – 10s and stands at 161 basis points tonight.
The reason we bring up this indicator is because the NY Federal Reserve has a 1-factor recession probability model and – you guessed it – the difference between 3-month and 10-year Treasury yields is that one factor. Their graph with data back to 1960, presented below, shows the probability of recession in the next 12 months:
Takeaway: we’re nowhere near triggering either this or the previously mentioned Treasury spread based recession indicator. That’s the good news. The bad news is that equity markets know to watch Fed Funds Futures for signs of where policy may go in the next year. As those continue to discount ever-higher Fed Funds rates, the market may fear that the risk of a Fed policy-induced recession is growing.