January 9 - Stocks are mixed at midday, with traders eyeing a big Treasury auction later this week. The VIX slipped below 13 again, while the dollar index firmed to trade near 102.5.Yields on 10-year Treasuries are trading near 4.01%, while yields on 2-year Treasuries are trading near 4.36%. The broader commodity complex found support today, with crude oil prices trading 2% higher on a renewed focus on Middle East risks, while the grain and oilseed sector is mostly higher as well. Gains are a bit larger for wheat, which saw big losses on Monday, while more modest for corn and soybeans. The protein sector is again trading weather premium, with a series of winter storms expected to challenge animal performance and packer operating schedules in the Plains and Midwest, with heavy snow and bitter cold temperatures spreading across the region in the days ahead.
The commodity sector started 2024 with the same bearish sentiment that clouded its outlook for much of 2023. In fact, we've been in commodity deflation mode since mid-June of 2022 as managed money fretted about the anticipated recession that was going to reduce demand for commodities. And we've seen that decline in demand for commodities, and we've seen a surplus of supplies relative to that demand. Throughout the past year and a half, we've seen managed money build short (sold) positions across the majority of commodities based on that expectation of soft demand as inflation pulled back amid recession expectations. Individual commodities would periodically rally when a bullish headline emerged, but that usually was due to speculative short-covering, with managed money quickly rebuilding short positions again once the headline died.
That's in sharp contrast to the period emerging from the initial Covid pandemic dip in the second quarter of 2020. The primary theme then was rising inflation expectations as the domestic and global economy opened up. An expansive economy means increased demand for raw commodities, while managed money also wanted to own commodities in their portfolios to hedge their inflation risks. The graphic below shows the correlation between our StoneX Commodity Tracker and the Five-Year Breakeven Inflation Rate - what the markets believe will be the average inflation rate over the coming five years. Those expectations are currently starting to level out. A correlation above 0.70 is considered to be statistically strong. The 10-year correlation shown below is a solid 0.87. The question before us then is, where do we go from here? Zero interest rates, and extremely low inflation rates, appear to be a thing of our past, and I agree with that. Rather, my bias is that we see a bounce in inflation expectations as we go deeper into 2024. That doesn't mean that I'm bullish commodities, but it does suggest that such a shift could result in managed money reducing or eliminating much of their short positions in the sector, and possibly build some ownership, making it easier for rallies to run when/if a story unfolds.
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