The oil market anomaly suggests that the inflation risk in the United States is underestimated! Vanguard asset management is counter-trend positioning to hedge against inflation with US bonds.

Unusual changes in the oil market are prompting Vanguard Asset Management to buy insurance against higher-than-expected US inflation lasting longer. Since the fragile ceasefire agreement between the US and Iran, the price of crude oil has dropped significantly, but the drop in gasoline prices has not kept up, leading to the largest price difference between the two since 2022. Alesh Courtney, head of international rates at Vanguard's active management fund, says he is closely watching the so-called "crack spread" to look for signs that finished oil prices may rise again and push up inflation. Courtney said in an interview, "We have never paid this much attention to this indicator before. Because crack spreads are typically highly correlated with oil prices, they have often been a secondary indicator in the past, but now the price trends of products like gasoline, aviation fuel, diesel, and fuel oil are showing significant differences from crude oil." Although crack spreads are a common indicator in oil trading, used to measure the difference between finished oil prices and crude oil prices, this data is often not closely monitored by bond investors. The Middle East conflict led to a significant decrease in global refinery fuel production, and ongoing attacks on Russian refinery facilities in Ukraine prompted Russia to ban diesel exports, further raising refinery profit margins. Despite falling oil prices, crack spreads continue to widen, becoming a focus of concern for some bond investors. Courtney said, "The question is whether this price difference will return to normal, or whether this low correlation will become a more structural feature and impact inflation risk." "These deviations could either strengthen inflation risks or weaken them, both possibilities are possible, and their impact could be significant." The two-year breakeven inflation rate, which measures the gap between nominal yields on US Treasuries and yields on Treasury Inflation-Protected Securities (TIPS), has been falling for the past month and is now near its lowest level in nearly two years. This suggests that the market expects US inflation to only slightly exceed the Federal Reserve's 2% target level two years from now. This trend has prompted Courtney and his team to build long positions in US short-term inflation-protected Treasury bonds (TIPS) and also to buy breakeven inflation trades with longer maturity curves. They believe the market is underestimating the possibility of sustained higher-than-expected inflation. This week, tensions in the Middle East have risen again after US President Trump expressed doubts about the ceasefire agreement between the US and Iran, leading to a sharp rise in oil prices. The Vanguard team is currently optimizing its model, including different types of petroleum fractions in addition to crude oil, in assessing inflation risks. Currently, traders expect the Federal Reserve, the European Central Bank, and the Bank of England to each raise rates by 25 basis points before the end of the year, and they also expect further tightening of monetary policy this year or next. Compared to the rapid escalation of rate hike bets in the market after the US-Iran war broke out in March, market expectations for further rate hikes have noticeably eased.