Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / Why Falling Inflation Expectations Override Rising Oil Prices
Transcript
- Lucas: Luna, we've seen oil rally hard this week — WTI futures up more than 5 percent over five days, Brent pushing toward 97. But here's the part that's actually interesting: the bond market's telling us this oil spike isn't going to stick. Luna: You mean the breakeven inflation rate? I saw it dipped to 2.26 percent on Friday. Lucas: Exactly. The 10-year breakeven, which is basically the market's forecast for average inflation over the next decade, actually fell a couple basis points as oil surged. That's the opposite of what you'd expect if investors thought higher energy costs were going to feed through permanently. Luna: So the market is basically saying this oil rally is a blip. What's the case for that? Lucas: Well, look at the data. Spot WTI is at 84.40 a barrel, up from 83.43 a week ago. That's a real move, but it's still well below the peaks we saw last year. Meanwhile, core CPI — which strips out food and energy — is basically flat at 336.1. And the 10-year breakeven has been trending down all month, from 2.28 to 2.26. So the market sees the oil spike as a supply shock, not a demand-driven inflation that will persist. Luna: And the Fed's credibility probably plays a role too — if people believe the Fed will keep rates high enough to contain inflation, then a temporary oil spike doesn't change the long-run view. Lucas: Right. In fact, the breakeven falling while oil rises suggests the bond market actually has more confidence in the Fed's commitment now than it did a month ago. That's a signal that energy prices alone aren't going to push the Fed off course. Luna: So if the market is right, what does that mean for energy stocks? They've been rallying too — XOM up, CVX up — but if the oil spike fades, those gains might not hold. Lucas: If walking through the economy with us has made something click about how these signals connect, the way we keep this show ad-free is listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. It's a small gesture that keeps this resource open for everyone. Luna: Yeah, and it really does help us keep the lights on and avoid ads. Appreciate anyone who chips in. Lucas: Back to the bond market signal — historically, when breakevens drop during oil rallies, it's usually because the supply disruption is expected to reverse. Think about the tanker strikes earlier this month: Brent spiked to 98, but within a week it was back to 87. That pattern reinforces the market's skepticism. Luna: So the question is: is this time different? We've got geopolitical risk, OPEC+ still cutting, and gasoline at 4 dollars a gallon. Lucas: Gasoline is actually a key part of the story. At 4 bucks a gallon, consumers feel it, but core CPI ex food and energy is flat. So headline inflation might tick up in July, but the Fed looks through that. And the bond market is saying the same thing — they're not buying a sustained inflation breakout. Luna: But what about the longer-term? If oil stays above 85 for months, doesn't that eventually feed into core via transportation costs? Lucas: It can, but the market's bet is that it won't last. Look at the futures curve — WTI for delivery in December is trading around 82, which is lower than the spot price. That's contango-light, but it suggests traders expect supply to come back online. Plus, the breakeven dipped even as oil rallied, meaning the bond market isn't worried about second-round effects. Luna: That's a pretty confident signal from the bond vigilantes. So for investors, the takeaway might be to not chase energy stocks on this move. Lucas: Exactly. If you believe the breakeven, then oil's gains are a tactical trade, not a strategic shift. And the fact that the 10-year breakeven is falling while stocks like Exxon and Chevron rally suggests the equity market is trading on momentum, not on inflation expectations. Luna: So the bond market is effectively calling the oil rally's bluff. Let's see if the data backs that up in the coming weeks. Lucas: We'll be watching. That's it for this episode of Energy Economics with Fexingo. I'm Lucas. Luna: And I'm Luna. Catch you next time.