February 14 – Stock futures posted a recovery bounce overnight, following yesterday’s sharp losses on hotter-than-expected inflation data for the second consecutive month. The VIX is trading near 14 this morning, after spiking to near 18 on Tuesday following the data release. The dollar index is trading near 104.9 this morning, following yesterday’s sharp rise to a three-month high near 105.0. Yields on 10-year Treasuries are trading year yesterday’s 10-week high near 4.29%, while yields on 2-year Treasuries are trading near 4.61%. Crude oil prices are again modestly higher, as they trade just below three-month highs on escalating geopolitical risks in the Middle East. Meanwhile, grain and oilseed prices posted new lows for the move across most markets overnight on the strength of the dollar amid expectations that high interest rates for longer will bring down inflation, keeping the commodity deflation mantra alive for a bit longer.
Commodity deflation historically has been the mantra during times of “high” interest rates when the thinking is that such will be bringing down inflation in the future. There’s a strong historical correlation between the Five-Year Breakeven Inflation Rate and our StoneX Commodity Tracker over the past 10 years. Managed money tends to build ownership in the commodity sector to protect their portfolio against inflation during times when it believes that inflation rates will be rising, and they tend to short the commodities during times when they believe that inflation will be trending lower. The Five-Year Breakeven Inflation Rate is now tracking sideways just above the 2% mandate, keeping the commodity deflation sentiment in place. That has changed in the past when the Five Year Breakeven Inflation Rate has turned higher – often with a two to three-month lag. That in the past signaled a switch in managed money’s view of the commodities. In other words, I’m watching for when sentiment flips from one of expecting high rates to bring down inflation to more of one that inflation is getting outside of the Federal Reserve’s control, moving higher. Fund managers would then have reason to question why they are short the commodities when perhaps they would want ownership to protect their portfolios from the eroding power of inflation?
Wall Street was unnerved yesterday by data showing stronger-than-expected inflation at the consumer level, for the second month in a row. Furthermore, it did so at a time when energy prices were dropping. What happens when energy prices rally again, as they’ve been doing thus far in February? Yesterday’s data showed the fastest growth in shelter prices since September, with that sector seeing 6% year-on-year inflation at this point. The surge in consumer sentiment over the past two months, combined with the recent drop in interest rates, created renewed demand for filling the lingering shortage of houses. Food prices are also on the rise, with four of the six major grocery store food groups showing inflationary pressures in January. Both the at-home and away-from-home food categories showed their strongest price gains of the past six months in January. These factors surely are a concern to members of the Federal Open Market Committee, especially considering the geopolitical risks in the Middle East that are starting to push energy prices higher. Now add to that rising freight costs associated with those same geopolitical risks as ships avoid the Red Sea, combined with limited flow through the Panama Canal due to low water levels. Ocean freight rates are rising for shipments from China to Europe and from China to the U.S. East Coast. Shipping routes are lengthened, keeping ships tied up longer on the same route, tightening the supply of ships. Air freight is also rising as shippers look to the air as an alternative. All of this tends to eventually reach the consumer with higher prices. The question for the commodity markets, in light of all the above, is when does managed money start worrying about a more substantial increase in inflation, pushing the Five Year Breakeven Inflation Rate higher, and influence their view of the commodities?
Corn, soybean, and wheat prices posted new lows for the move overnight, with corn prices posting new three-year lows, and Kansas City and Minneapolis wheat posting more than 2-1/2-year lows. The current sentiment is that a strong dollar makes it more difficult for these commodities to compete on the global market in a time when global supplies are more than adequate. Many of these markets are oversold, with managed money holding massive short positions. But thus far, there isn’t a headline to create concern among these money managers to cause them to change their positions. End users are being rewarded for buying on an as-needed basis. At some point that sentiment will change, and perhaps change quickly, but that is not the case thus far. South American weather is currently generally supportive for crop production, and no real threats are currently on the horizon for the North American growing season either. As such, the current trend remains in place.
