A year ago Saturday marks the bottom in oil – this means the base effect of low oil prices will begin to recede from inflation/reflation indicators. The broader US equity market has climbed on the back of the materials, industrials and various infrastructure plays – this is the so-called reflation trade. While this equity rally occurred the bond market was pricing in higher inflation. Interestingly, the 5 year break-even inflation rate was indicating almost no YoY growth in November 2016, since then inflation expectations have soared.
The following chart shows the YoY % change in 5 year inflation expectations and the YoY% change in WTI Crude Oil Prices. As you can see there is a very close relationship.
This means that the direction of the price of oil is probably more important than any other single factor when trying to determine if the reflation trade will continue. On February 11, 2016 crude oil hit the lowest price since the financial crisis.
This means that moving forward the effect of low oil prices will be muted and likely result in falling inflation expectations. In turn, this could make the bonds bears decidedly bullish. BK is long of TLT.