Sticky inflation is a lie, or yields should go up

Global risk appetite remains contained ahead of Friday’s US jobs data. Since the beginning of the pandemic, reports are highly volatile and predictions are relatively ‘random’, therefore the looming uncertainties should prevent investors from engaging in the remarkable price action on the index level before the data release. Activity on European and US futures hint at a lackluster start on Wednesday, and the trading will likely remain rangebound into Friday.  

But one sector stands out this week: energy. It looks like the sun is shining again over the oil stocks, after a week of drama and selloff due to a rising and material pressure for cutting their greenhouse emissions and aligning with the climate change goals. Oil stocks outperformed on Tuesday, as this week, the main driver of price action is firming oil prices following OPEC+ decision to increase the global oil supply gradually only, despite prospects of improved global demand, waning global glut, and rising rumors of an eventual reversal in global demand-supply dynamics, from too much supply to not enough of it.  

And that’s a dream for oil producers: they sell less for a higher price and make better profits. There is one problem though: lingering inflation worries. A quick rise in oil prices would add fuel to inflationary pressures and have a curbing effect on global recovery. A slower global recovery, in return, would weigh on oil prices and on OPEC’s revenues. So, it is a subtle balance that should be managed carefully.  

Nonetheless, OPEC is consolidating power in its hands right now and the long oil strategy could rely on a solid safety net. The prices will certainly not overshoot to $100 per barrel, in which case it would dampen the global demand, but they will likely stabilize and push above the $70 per barrel handle. 

There are two risks to the bullish oil view: the risk of a renewed Covid crisis and unpredicted retreat in global oil demand, and the risk of Iran pumping more oil as their export restrictions get lifted. But even with the looming risks, WTI should see solid support within the $65/63 PB area, which corresponds to a psychological level and the 50-day moving average, respectively.  

A final word on the US yields and gold. Looking at the market price action, a sticky inflation consensus is probably non-sense. If the market walked the talk, then the US 10-year yields would have been much higher, above the 6% threshold according to a Macrobond and Nordea regression on core inflation and US 10-year yield over data collected since 1985.  

So, there are two options. Either inflation will slow down, as the Federal Reserve (Fed) predicts, and the core inflation retreats below 2% in the second half of the year to give way to a reasonable rise in US 10-year yield toward the 2-3% zone. Or the inflation will stick around, and the bond yields will need to readjust to it. And the more we wait, the sharper the jump would be, as core inflation near 2% would match a 10-year yield within the 3.5/4% area, based on the same regression. In both cases, we should, at some point, start seeing negative pressure on the non-interest-bearing gold. And, of course, the risk of a rapid rise in the US yields would dramatically weigh on the bullion’s price. For UBS analysts, gold prices could remain elevated in the short run as markets are pricing in an excessive incremental decline in real rates. Yet, they expect real rates to rise and predict the gold price falling back toward the $1600 per oz over the next twelve months.