Cross-Asset Dispatches : Are You Just Trading Oil?
Asset correlations with oil have risen to some of the highest levels in the last 25 years. They don’t tend to stay that way for long.
Falling oil and a familiar pattern: Falling oil prices widening credit spreads, declining yields, flatter curves, lower inflation breakevens and struggling equity markets are an all-too-familiar pattern. Similar to January (and even before the RMB headlines), these movements are driving fears around growth and a cycle turn.
These linkages are unusual: The relationship between many asset classes is far stronger than normal, in many cases some of the highest correlations in 25 years. This is especially notable given that the drivers of oil’s weakness are unusual, a function of supply more than demand.
What’s ahead for oil? We get the latest thoughts from our commodity team. Near-term challenges to oil prices remain, but the team’s view that current prices do not represent a ‘new equilibrium’ has important implications.
Implications: We think that US HY credit (even ex-energy) risk premiums are high enough to make it attractive despite short-term oil headwinds. Energy equity has the asymmetry of upside to further oil price moves as companies adapt cost structures. For patient investors, long-dated breakeven inflation should be less sensitive to short-term oil weakness.