RECENT WEAKNESS IN COMMODITY MARKETS MAY BE GOOD NEWS FOR THE FED -- THE BLOOMBERG COMMODITY INDEX HAS WEAKENED ALONG WITH MOST COMMODITY GROUPS -- THE UPTREND IN OIL MAY ALSO BE WEAKENING -- ENERGY SPDR HAS ALREADY FALLEN BELOW ITS MOVING AVERAGE LINES
COMMODITY PRICES WEAKEN ... One of the factors the Fed is now considering to help formulate its monetary policy for the rest of the year is the question of inflation. Rising inflation puts pressure on the Fed to raise rates. Flat or falling inflation allows the Fed to stick with its current policy of keeping rates flat for the foreseeable future. Commodity prices are one of the best ways to monitor inflation trends. Which is why the Fed can take some comfort from the recent drop in commodity prices. Chart 1 shows the Bloomberg Commodity Index ($BCOM) dropping over the past month after meeting resistance at its 200-day moving average (red line) near the start of April. The BCOM has also fallen back below its 50-day average (blue line). That drop over the past month has been led by agricultural prices, as well as industrial and precious metals. The three charts below Chart 1 show agricultural prices leading the commodity drop, followed by industrial and precious metals. An upside breakout in the U.S. Dollar Index to a two-year high during the month probably contributed to some of that selling. The one commodity group that held up better was energy. But that rally is now being challenged. And that's putting energy shares under pressure.
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Chart 1
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Chart 2
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Chart 3
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Chart 4
THE UPTREND IS OIL IS BEING TESTED ... Chart 5 shows the United States Oil Fund (USO) having recently traded at a six-month high. In so doing, the USO has also risen above its red 200-day moving average. The ability of the USO to stay above that important support line will help determine if the price of oil is going to follow other commodity prices lower. Short-term momentum indicators aren't very encouraging. The 14-day RSI line (upper box) is in danger of falling below its midpoint 50 line for the first time since the start of January. Daily MACD lines (lower box) have already turned negative. The direction of oil is the one of the main gauges of inflation that the Fed looks at. The recent dip in the price oil is already taking a negative toll on energy shares.
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Chart 5
ENERGY SPDR FALLS BELOW MOVING AVERAGE LINES... Chart 6 shows the Energy Sector SPDR (XLE) falling back below its 50-day and 200-day moving average lines. To make matters worse, the XLE/SPX ratio (solid line) has fallen to the lowest level of the year. That's not good either. Materials stocks tied to base and precious metals have also been dropping. That may not be a good sign for holders of those stocks or their commodities. But it might be viewed as good news for the Fed because it implies that inflationary pressures are still not a threat to the economic recovery. And allows the Fed to stick with its current holding pattern on interest rates. Falling commodity prices are also helping keep bond yields down which is supporting bond prices and stocks tied to them. That includes dividend-paying consumer staples, utilities, and REITs which continue to attract investor attention. They've been among this week's strongest stock sectors. While stocks tied to energy and materials have been the weakest.
