As the oil price, a key component of the inflation calculation, has fallen, US market expectations for future inflation rates have slid too. But investors may be overdoing it, reckons Alejandro Badel, writing on St Louis Federal Reserve Bank’s blog. Badel and colleagues looked at what the market expects US consumer price inflation to be over the next decade.
They then looked at what that implies for US oil prices, assuming the historical relationship holds. On that basis, the oil price would have to fall to $0 a barrel by mid-2019 (the red line on the chart) to validate current inflation expectations – even though oil futures (the blue line) predict a gradual recovery. Time to tweak the underlying models?