Forward prices in commodity and bond markets consistent with rapid slowdown in CPI

Annualized CPI at 8%. Crude oil at $105/barrel. The yield on 10-year government bonds is 2.7%. These price levels constantly scrolling across computer screens and TV sets tell the story of a macro environment undergoing material change.

But while investors are actively re-pricing assets in the spot markets, they are also betting on where those assets will trade in the future. Most financial markets have actively traded futures markets, which, taken together, describe a macro landscape that could be very different from the current one. The good news is that these markets are predicting inflation nearing its peak. The bad news is that a successful fight against inflation will come at the cost of a slowdown in global growth.

Viewing the economy on a forward basis through futures prices gives you insight into what investors expect over a period of time. By knowing what has been priced in in the markets, investors can forward story and adjust positions based on whether that predicted scenario is likely to unfold. Here’s a quick look at where some of the major asset classes are priced a year ahead:

Forward inflation

Inflation of 8.5% is pretty scary. However, such high levels are not expected to last. The one-year inflation starting in one year, known as 1-year inflation, is 3.5%. While it is still higher than the average rate of the past ten years, it is significantly lower than the current annualized rate of 8.5%. The inflation forward market tells us that investors believe the CPI has nearly peaked and will slow dramatically in the coming years.

Forward energy prices

The jump in energy prices is a function of an imbalance in supply and demand. A lack of new domestic supply from the US and the slowdown in exports from Russia, coupled with renewed demand as the world emerges from the pandemic, has led to a spike in spot oil and gas prices. However, the futures market predicts that the recent $100+ crude oil levels will not last that far into the future. In May 2023, WTI crude oil futures will trade at $89 a barrel, compared to May 2022 futures at $103. The market expects either a resumption of supply to correct the imbalance or a slowdown in the aggregate global demand will push prices down again.

Term Interest Rates

Anyone who follows the bond market knows that short and long-term interest rates have risen in recent months. Bond yields have soared and the yield curve has flattened. The recent sell-off has arguably been one of the most violent in decades. Fortunately for bond investors, futures markets are telling us the worst may be over. The current shape of the yield curve expects 1-month government bond yields to rise nearly 300 bps over the next year, but 30-year yields by only 5 bps. To be clear, this is not a prediction; it is what the futures markets are currently pricing. The bond market predicts that the Fed will raise interest rates aggressively in the coming year, but long-term interest rates have already hiked most of the adjustments.

Everything in a row

Looking at the different futures curves to see what’s priced into financial assets, it’s not hard to form a story that’s very different from the one that currently dominates the headlines. While spot markets tell a story of spiraling inflation, rising bond yields and skyrocketing energy prices, futures markets predict a macro environment that is significantly more optimistic.

Futures markets predict that inflation will moderate in the coming year, mainly due to lower energy prices, which could help the Fed prevent interest rates from climbing well above 3%. Financial markets are not anticipating a 1970s scenario of prolonged inflation, continuously rising oil and gas prices, or double-digit bond yields. That’s positive. However, the common thread that would enable futures markets to accurately predict the future is a material deterioration in global growth.

Forward crude oil prices, inflation swaps and bond yields are consistent with a global economy that has overcome supply chain bottlenecks and is expected to slow in the coming year as higher interest rates negatively impact consumer and business demand. If you don’t believe that story, place your bet on forward, not spot markets.

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