U.S. Bond Market Week In Review: Diverging Oil Price Predictions And Rising Junk Yields

One of the central debates occurring within the Fed regards the causation of current inflation weakness. Some, like Fed President Bullard and Chairman Yellen argue low oil prices are solely responsible for the weakness. Others like President Brainard and Chicago Fed President Evans see a more nuanced picture involving declining international trade negatively impacting a wide swath of commodity prices. Regardless, this week various organizations published stories to support and counter each argument.As for oil prices, Goldman Sachs sees oil prices at $20 in the next 12 months. 

Goldman Sachs told clients that the increasing glut of oil on the global market has combined with mild weather from a freak El Nino this winter. The twin-effect could send prices plummeting to $20 a barrel, the so-called ‘cash cost’ that forces drillers to abandon production. “Risks of a sharp leg lower remain elevated,” it said.

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The US investment bank said the overall glut in the commodity markets may take another twelve months to clear. It cited ‘red flag’ signals on the Shanghai Future Exchange over recent days. Copper contracts point to “imminent weakening” in China’s ‘old economy’ of heavy industry and construction, it said.

In contrast, Ecstrat strategist Emad Mostaque, writing on the FT’s Alphaville argues prices will rise about $100 for two reasons: increased Middle Eastern tensions and solid demand. The ME situation hardly needs elaboration.Here are his thoughts on demand:

Demand is healthy, driven by China and the US in particular. High crack spreads have kept gasoline above $2.50 per gallon in the US, but as refineries come off heavy maintenance this could fall below $2.00 even if oil prices are flat, increasing demand. Chinese demand is likely to plateau but remain solid even as the economy rebalances and slows.

Both sides have ample merit. 

However, assuming a broader swath of commodity price declines is the reason for weak inflation, a Fed rate hike might create additional problems: