INTEREST RATES RISE ON INFLATION REPORTS -- STOCKS PULLBACK -- ENERGY HAS A BAD WEEK
TEN-YEAR YIELD TESTS 3.90%... Bond yields climbed this week on two reports showing that inflation gained during January. Chart 1 shows the 10-Year Treasury yield testing some resistance at 3.90% formed at the end of December. A close above that level would put the TNX at the highest level in three months. The 2-Year yield which is more sensitive to expected Fed hikes has already reached the highest level since November. That combination of rising rates caused more profit-taking in stocks. No trend changes, however, have taken place.
S&P 500 TESTS 50% RETRACEMENT LINE... Last week's message showed Russell 2000 iShares which track small cap stocks backing off from resistance at its August peak. The S&P 500 hasn't reached its August high but is testing another resistance line. Chart 2 applies Fibonacci lines to the S&P 500 measured from last January's high to its October low. And it shows the SPX meeting resistance at its 50% retracement line (middle line). That's a normal spot to expect some profit-taking. The SPX, however, remains above its moving average lines which keeps its 2023 uptrend intact. Despite this week's uptick in CPI and PPI inflation, commodity prices remain on the defensive.
COMMODITY PRICES DROP... We normally look to commodity prices to help determine the path of inflation. Chart 3 shows the S&P GSCI Commodity Index dropping this week and nearing a possible test of its recent lows. No signs of inflation there. What's interesting is that commodity prices and bond yields often trend in the same direction. That's because higher commodity prices usually signal higher inflation. Their different direction was highlighted this week with bond yields rising with falling commodities. In fact, they've been trending in opposite directions for most of the last year. It remains to be seen which one is right about the path of inflation.
LONGER TERM VIEW... The monthly bars in Chart 4 shows bond yields and commodity prices trending in the same direction of most of the last ten years. After falling together during 2019, they bottomed together during 2020 and rose together during 2021. In fact, it was the sharp rise in commodity prices that warned of rising inflation pressures which helped push bond yields higher. To the upper right, however, commodity prices dropped for most of the last year while bond yields gained. While falling commodity prices may be signaling that inflation prices are easing, that could also be a sign that the economy is weakening. Commodity prices normally weaken along with the economy during a recession.
ENERGY SPDR FALLS WITH COMMODITY... Speaking of weaker commodities, crude oil lost -3% of its value this past week which helped make energy shares the week's worst sector. Chart 5 shows the Energy Sector SPDR (XLE) falling to the lowest level in six weeks. Last week's message suggested that the XLE might be forming a potential "triangular" formation as shown by the converging trendlines. This week's lower price action, however, is testing that view. The Dollar Index rose to a six-week high this week which may also be putting downside pressure on commodity prices.
