Goldman's Garzarelli Says US Inflation Market 'Pricing In Sharp Deceleration Of CPI' Or A 'Material Risk Of A Crash In Crude Oil'

In a new report, Goldman Sachs analyst Francesco Garzarelli discusses the apparent disconnect between the U.S. inflation market and the price of crude oil. According to Garzarelli, the inflation market is either pricing in a sharp decline in CPI or a further crash in oil prices.

“Using an admittedly mechanical approach, we calculate that WTI, which is currently trading at US$32/bbl, should fall to around US$23/bbl by Dec-16 and to around US$16/bbl by Dec-17 to generate the headline inflation profile priced by the market with core CPI remaining roughly stable at 2%,” Garzarelli explains.

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Conversely, the inflation market could be pricing in a ”sharp deceleration” in core inflation, which would likely mean that the U.S. is in for a severe recession.

Goldman believes that an oil price crash scenario is the more plausible outcome, but the firm’s commodity team believes that a drop in WTI prices to the $15-20/bbl range would likely not last long and would result in a sharp subsequent bounce-back.

“All told, we continue to think that – on our baseline case for the economy – US 10-year breakeven inflation (currently trading at 130bp) is at least 50bp too low,” Garzarelli concludes.

In the past two years, the United States Oil Fund LP (ETF) USO is down 77.0 percent.

Disclosure: the author holds no position in the stocks mentioned.