COMMODITY PRICES CONTINUE TO RISE WHICH SUGGESTS MORE INFLATION -- RISING COMMODITIES ARE BOOSTING BOND YIELDS AND THE YIELD CURVE
CRB INDEX BREAKS TRENDLINE RESISTANCE... The current rally in commodity markets is attracting a lot of attention. Not just because commodities represent an asset class that's been attracting a lot of money over the last year. But also because of their intermarket implications. Stronger commodity markets are usually dependent on a stronger global economy. That's especially true of economically-sensitive commodities that are dependent on global demand. Rising commodity prices also imply rising inflation which puts upward pressure on bond yields. Stronger commodities are also usually associated with a weaker dollar which also carries inflationary potential. The big question now is how strong commodity prices really are. And what barriers they need to overcome to continue their current uptrend.
The weekly bars in Chart 1 show the Reuters/Jefferies CRB Index which has just broken through a falling trendline drawn over its 2018-2019 highs. That's a positive sign and paves the way for a test of its late 2019 high near 187. That's the next test that it needs to overcome. Odds look pretty good that it will be exceeded. Let's take a longer-range look.
A LONGER RANGE LOOK AT COMMODITIES... The monthly bars in Chart 2 show the huge downturn in commodities that lasted from 2008 to the beginning of 2020, and what it needs to do to reverse that major downtrend. The chart is also plotted on a log scale which usually works better on longer range charts. The most dominant feature in Chart 2 is the major down trendline that connects highs formed during 2008 and 2014. That resistance line currently sits near 200 which is just below the peak formed in the early part of 2018. The CRB Index needs to clear that major resistance line to confirm that a bottom is in place and that a new cycle of rising commodities has begun.
SHIFTING FROM DEFLATION TO INFLATION... The Fed appears to be rooting for the commodity rally to continue. Weak commodity prices over the last decade were reflective of deflationary tendencies that existed during that period. This year's higher commodity move signals a shift to a more inflationary environment which the Fed is trying to achieve with its easy money policies. From a monetary standpoint, it's much easier for the Fed to deal with inflation by raising interest rates which it's in no hurry to do. Fighting deflation is much harder to do. Which is why the Fed now probably welcomes rising commodity prices which will in time lead to higher consumer prices.
COMMODITIES AND BOND YIELDS... The direction of commodity prices also plays a role in the direction of bond yields. That tendency can be seen in Chart 3 which compares the CRB Index to the 10-Year Treasury yield over the last fifteen years. Periods of weaker commodity prices had a tendency to pull bond yields lower. That was especially true during 2008, 2014 through 2015, and especially during 2019 and early 2020. The boxed area to the bottom right of the chart shows bond yields rising with commodity prices over the last year. The daily bars in Chart 4 show both markets rising together since last spring. That rise in bond yields has also resulted in a steeper yield curve over the last year.
COMPARISON OF COPPER AND STEEPER YIELD CURVE... With the Fed holding short-term rates near zero, the spread between long and short term yields has widened. That's due to the rise in longer-maturity bond yields. That's the green line in Chart 5 which plots the 10 - 2 year yield curve which has risen sharply over the last year. Rising commodity prices also played a role there which can be seen by the rising red bars which plots the trend of copper. Copper is an industrial commodity which is very sensitive to the strength of the global economy. Its sharp rise over the last year has had a lot to do with the steepening yield curve. All of which carries some important intermarket messages.
RISING COMMODITIES BAD FOR BONDS... The most direct result of rising commodity prices is falling bond prices. That in turn contributes to a rotation out of bonds into stocks or commodities which rise together in that more inflationary environment. Rising commodity prices also boost certain market sectors like energy and materials; while rising bond yields and a steeper yield curve benefit financial stocks and banks in particular. To the extent that rising bond yields also reflect a stronger global economy, that favors stocks and commodities at the expense of bonds.
