With oil prices collapsing this year amid a widening supply glut, one technician sees another reason to be worried about crude — namely, an economic indicator in the bond market.
Rich Ross of Evercore ISI is watching the yield spread between thetwo-year and 10-year Treasury notes, which measures the difference between the bond yields. Compared to the chart of oil, the two seem to move in very close correlation, he said Thursday on CNBC’s “Trading Nation.”
However, Ross said the spread has stayed alarmingly low, even after the Federal Reserve decided to raise the federal funds rate on Wednesday. As a measure of economic growth, he said, a declining spread may mean weak global demand will hit oil prices even harder.
“As long as that trend continues, a flatter curve with lower 10-year yields and higher two-year yields, crude is not going anywhere but down,” Ross said.
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In a healthy economy, yields generally rise as the length of time that the bond is held increases. If investors are optimistic about the economy’s outlook, higher bond yields compensate for expected inflation as well as alternative investing options that may make more returns. Inversely, if short-term interest rates move closer to or exceed long-term rates, that may indicate economic weakness or even an impending recession.
“Those [short-term] interest rates are moving higher on the back of Fed liftoff, but the 10-year isn’t going anywhere, telling us that it doesn’t expect commensurate growth to reinforce that,” Ross said. “That’s what we don’t want to see.”
Boris Schlossberg of BK Asset Management also said that until the yield spread between the two-year and 10-year notes begins to widen, oil prices should remain under pressure. And while crude oil may see some periodic spikes in prices, especially as short sellers cover their positions, Schlossberg said, the ultimate trend is still down.
“It’s ultimately all about global demand. And global demand looks pretty depressed as we stand here right now in front of 2016,” he said Thursday on “Trading Nation.”
However, Schlossberg cautions investors not to assume a causal relationship between oil and the Treasury spread.
“I do agree with that chart, but I do want to warn everybody, of course, that correlation does not mean causation,” he said.