Is inflation peaking? Commodities could tell the story…
Joseph Kennedy, the father of the 35th president, is said to have said just before the crash of 1929: “If the shoe shiners are giving stock advice, then it’s time to get out of the market”, says Brett Friedman from Winhall Risk Analytics.
Although most likely apocryphal, he points out that we all have our own personal overbought/oversold indicators. For me, it’s when distant relatives start asking me what’s going on in the “stock market” or whether they “should be worried”.
As you can probably guess, inflation and the specter of a return to the bad old days of 1970s stagflation are on many people’s minds right now. The latest June CPI figures of 9.1%, a 41-year high, are cause for concern. Using my personal overbought/oversold indicator and some recent commodity price trends, could this be a sign that inflation is peaking?
Raw materials could tell the story. Many speculated that the supply disruptions, resulting from the war in Ukraine, heralded the start of a new commodities supercycle and recommended that investors consider including commodities in their portfolios. . As the most doomsday predictions fail to materialize and the military stalemate drags on, war no longer provides the physical and psychological shocks needed to sustain the commodity rally. US-based markets have grown accustomed to war and have moved on to inflation and recession as the predominant headlines.
At the same time, signs of an impending recession, demand destruction due to high prices (witness, gasoline) and a dollar at or near parity with the euro also weighed on commodity prices. Although it didn’t get much attention from the popular press, prices for energy, agriculture, metals and lumber have fallen since early June, and significantly so. Indeed, the Goldman Sachs Commodity Index (GSCI) peaked on June 8 and has fallen 19.4% since then, along with other key commodities:
The link between commodity prices and inflation has been studied by the St. Louis Fed, which concluded that “commodity prices that have a relatively high energy component are more strongly correlated with headline inflation than commodity price indices composed primarily of metals or agricultural commodities.”
Interestingly, and despite the fact that commodity prices have fallen to more “normal” levels, their implied volatilities have increased (see above). The main underlying factors are the magnitude and speed of declines and the tendency for implied commodity volatilities to rise as commodity prices fall.
Bottom line: Going forward, sharp declines in commodity prices should help ease inflationary pressures in the US and could argue for less aggressive policy from the Fed.
Let’s review the evidence for a few product groups.
The first is the group that has received the most attention in recent months, energy and more specifically gasoline. Detail Gasoline prices (RB=F) (which led the June CPI figure), have moderated slightly in recent weeks, reflecting the 24% decline in futures prices since early June.
Clearly, gasoline has been affected by the drop in crude prices. Notice the implied volatility of Crude – as is the case with most commodities it is very sensitive to price declines and posted its highest value on record (197.4%) when Crude turned negative intraday in April 2020. The same goes for gasoline.
Of particular note is the 23% increase in natural gas volatility since June 24 and the slight rise in prices. Apparently, US natural gas is still affected by Putin’s threats to cut European supplies, albeit to a much lesser extent than in European natural gas markets. The specter of rationing for the coming winter hovers, especially in Germany.
Chicago wheat (ZW=F) is showing some of the most impressive declines in the agricultural sector and is down more than 25% since June 8, with a commensurate increase in implied volatility. Similar movements have occurred in corn and soybeans.
Finally, lumber, a relatively obscure commodity that became the headliner of commodity price inflation at its peak on March 4, has fallen almost 37.4% since then. during.
Next come metals, especially copper, which is down more than 25% since the start of June 8.
Finally, we have the deflationary impact of the euro and its march towards parity with the USD:
Commodity prices are at the forefront of the Fed. “What we’re really trying to do is just get [commodity prices] to stop going up. If it stabilizes… then the inflationary effects disappear. We don’t need them to actually fall back,” Fed Governor Christopher Waller said in early July. If we take Governor Waller at his word, and given the deflationary effects stemming from the commodity price declines shown above, an argument could be made against further significant rate hikes.
Learn more about Brett Friedman here.