BONDS AND STOCKS LIKE DOVISH SOUNDING FED -- LOW INFLATION IS KEEPING THE FED CAUTIOUS -- A WEAKER DOLLAR MAY BE HELPING COMMODITIES -- LONG-TERM CHARTS SUGGEST THAT COMMODITIES MAY BE BOTTOMING -- DROUGHT CONDITIONS BOOST GRAIN PRICES

FALLING DOLLAR MAY GIVE FED A HAND... Bonds and stocks are reacting very positively to written comments by Janet Yellen before Congress today. Her comments are being interpreted as being more dovish than anticipated, owing mainly to Fed concerns about persistently low inflation. It's hard for the Fed (and other central bankers) to get too aggressive hiking rates when inflation is so low. As a result, bond yields fell today as bond prices rose. Stocks are having an especially strong day around the world. Since inflation is such a big part of the story, I'm going to focus on commodity prices today which are one of the main parts of the inflation picture. There may be some good news there. But it starts with the U.S. dollar. Any hesitation by the Fed could serve to weaken the dollar, especially with foreign central bankers turning more hawkish. Chart 1 shows the PowerShares Dollar ETF (UUP) having already fallen to the lowest level since last September. One of the normal side-effects of a weak dollar is that it usually gives a boost to commodity prices. We may finally be seeing some of that happening. That would be good news for the Fed.

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Chart 1

COMMODITY PRICES MAY BE BOTTOMING ... I continue to maintain that one of the main reasons why global inflation has remained so stubbornly low since the financial crisis has been falling commodity prices. A glance at the Bloomberg Commodity Index ($BCOM) in Chart 2 will show how much commodity prices have fallen since 2008. In fact, they've lost 69% in the past nine years. Economists need look no further to explain why inflation has failed to respond to monetary stimulus over that time span. Chart 2 suggests, however, that commodity prices may have finally hit bottom. The monthly price bars show the commodity index hitting a bottom at the start of 2016. After rallying throughout the rest of that year, they've slipped again in 2017. But they remain well above their 2016 low. In addition, the 14-month RSI line (overlaid on the price bars) also appears to have bottomed, and looks much stronger than the price bars (see arrows). That "positive divergence" hints at a commodity bottom. So do the monthly MACD bars (below chart) which are also in positive alignment.

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Chart 2

WEEKLY BARS ALSO SUGGEST A POSSIBLE BOTTOM ... The weekly bars in Chart 3 also suggest that a bottom is being formed in the Bloomberg Commodity Index. First of all, the horizontal lines show the commodity index starting to rally from a 62% Fibonacci retracement of its 2016 rally. That usually acts as an important support line during market pullbacks. In addition, the 14-week RSI line (top of chart) is starting to rebound from oversold territory near 30. And weekly MACD lines (below chart) may be about to turn positive. Its moving averages are still in negative alignment, with its 10-week average (blue line) below its 40-week average (red line). The index, however, is trading back over its 10-week line which is a positive sign. The chart suggests that commodity prices may be in the process of forming a major bottom that started in early 2016. To confirm that, however, the BCOM still needs to clear a lot of overhead resistance barriers.

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Chart 3

POWERSHARES ENERGY FUND IS BOUNCING OFF CHART SUPPORT... The most important part of the commodity complex is energy. So let's start there. Chart 4 shows the PowerShares Energy Fund (DBE) starting to bounce off important chart support along last summer's low. That previous low also represents a 62% retracement of 2016 gains. [DBE includes crude oil, gasoline, heating oil, and natural gas]. Obviously, the direction of energy prices will play a key role in the direction of commodity prices. They're also an important part of the Consumer Price Index (CPI). Even if the Fed chooses to ignore energy prices in its core inflation readings, higher energy prices would contribute to higher inflation numbers.

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Chart 4

BASE METALS HAVE ALSO BOTTOMED ... The monthly bars in Chart 5 show the PowerShares Base Metals Fund (DBB) having also bottomed. They show the 2016 bottom to be a successful test of its early 2009 bottom. Since then, the DBB has cleared a major resistance line extending back to 2011. [The DBB includes aluminum, copper, and zinc]. All three are rebouding. Chart 6 shows the DBB rising to the highest level in three months after finding support near its 200-day average (red arrow). That's giving a boost to commodity prices in general. Precious metals, which are more sensitive to interest rate direction, have been weakening.

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Chart 5

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Chart 6

CORN AND WHEAT PRICES ARE RISING ... Food commodities are also starting to rise. Chart 7 shows the price of corn rallying to the highest level in a year. That's going to raise the cost to feed chickens and livestock. Livestock prices are already rising. Chart 8 shows wheat surging to the highest level in two years. A lot of the gains in corn and wheat are the result of drought conditions in the midwest. Spring wheat in particular has been badly affected and has jumped 40% over the past month. That's going to raise the price of bread. Those gains are also helping boost broad commodity indexes. Economists may have to start including higher food prices in their inflation calculations.

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Chart 7

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Chart 8

COMMODITIES ARE A DOUBLE-EDGE SWORD... I've written several books analyzing the role of commodity prices in past business and stock market cycles. In the past, rising commodity prices usually forced the Fed to hike interest rates which ended many of those cycles. That led to stock market peaks which often led to the start of recessions. This time is different. Deflation has been a bigger threat than inflation during the current cycle. Rather than fearing inflation, central bankers are doing everything in their power to get it rising again. Recent action in several commodity markets suggests they may get their wish. The Fed excludes commodity prices from its core inflation numbers. It would be ironic if commodities provided the first sign of rising inflation. But there's a double-edge sword there. Right now, low inflation is acting as a restraint on the Fed and other central bankers which is helping support bond and stock prices. Higher inflation could result in a more aggressive Fed. That wouldn't be good for financial markets.