Market Extra: Investor’s forecasts for inflation climb as copper, oil prices notch multiyear highs

Inflation expectations as measured by the bond market have risen to their highest levels since April as prices for key commodities hit multiyear records this week.

Crude futures CLG8, +0.85%   touched $60 a barrel for the first time since June 2015 this week on inventory reports that were bullish for prices and after a Libyan pipeline exploded, disrupting oil supplies from a key member of the Organization of the Petroleum Exporting Countries. Meanwhile, copper prices HGH8, -0.30%   rose to a four-year high after reports showed Chinese imports for the red metal climbed 19% in November.

As crucial ingredients to the global economy, both commodities can have a knock-on effect for inflation and tend to rise when growth expectations heat up. This comes as the Federal Reserve—and other main central bankers—has struggled to understand why inflation has failed to hit its 2% annual target even as slack in the labor market reaches the tightest levels in decades.

The 10-year break-even inflation rate, derived from the 10-year yield for Treasury inflation-protected securities, or TIPS, rose to 1.97% on Thursday, its highest since April 5, according to data from Tradeweb. The break-even rate has steadily climbed from 1.66% on June 21. Tracking TIPS is often used to gauge where investors think future inflation levels will be.

The iShares TIPs Bond ETF TIP, +0.23%   have risen 0.6% this week to $113.83.

Inflation expectations have rebounded since June

See: Is it time for investors to worry about rising oil prices?

Read: Oil ends at a 52-week best, and near highest since 2015, on supply disruptions

But analysts said rising prices for raw materials have struggled to translate into stronger inflation expectations as bond investors have been unsure whether the climb in commodity prices was backed by underlying shifts in, say, the demand and supply for oil, or reflected the bullish bets from short-term investors who could exit their wagers on a dime.

In other words, it can be unclear whether higher commodity prices represent ephemeral shifts or longer-term trends.

“Speculators were long copper and long oil, with the view let’s see if [higher commodity prices] last. Now, you slowly get people redressing their concerns about inflation,” said Jim Vogel, interest-rate strategist at FTN Financial.

Hedge funds and other speculative traders placed 614,500 bullish bets on crude oil as of the week dated Dec. 15, an all-time record, according to data from the Commodity Futures and Trading Commission.

A more mundane reason why inflation expectations have risen toward the close of 2017, could be that bond investors are resetting their economic forecasts.

“Analysts tend to show optimism over higher inflation and higher interest rates when the year starts out, but as the year progresses and those expectations don’t play out, the market resets. We’re seeing some of that right now,” said Craig Bishop, lead strategist for RBC Wealth Management’s fixed-income strategies group.

But Vogel was unsure the bond market’s prophecies of stronger price pressures next year would be fulfilled. He said that the individual components of the basket of goods and services that made up the consumer-price index and other inflation gauges have been softening over the past year.

“You have to take a real hard look at the individual components of inflation, which are either flat or falling right now. That goes against the very idea that tight labor market will push inflation higher,” said Vogel.

Though employers have struggled to find workers, they have been unwilling to raise wages. For economists who hew to the so-called Phillips curve, a theory stating that low unemployment tends to coincide with high inflation, this year has thrown doubt on this widely adopted inflation framework used by economists and central bankers.

Core CPI stripping out for energy prices has hovered at 1.70% since May.

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