Due to the highest inflation rate in 40 years, the Federal Reserve this week hiked interest rates to the tune of 0.5%, the largest single rate hike since 2000. Historically, the Fed raises or lower rates by 0.25%.
The reason for the larger hike was because the Fed is simply reaffirming its intent to be more aggressive in fighting inflation. And the vote to raise rates was unanimous — with more rate hikes to come in the months ahead.
From Investopedia: “When the Federal Open Market Committee changes the interest rate, it impacts both the economy and the stock markets because borrowing becomes either more or less expensive for individuals and businesses. Any impact on the stock market to a change in the interest rate changes is generally experienced immediately, while for the rest of the economy, it may take about a year to see any widespread impact.”
Historically speaking, higher interest rates tend to negatively affect corporate earnings, stock prices and the commodity markets in general. There is nothing bullish about higher rates, which is why the Fed uses that tool to fight inflation.
However, Investopedia is correct in that “for the rest of the economy, it may take about a year to see any widespread impact.”
How did a handful of commodity markets perform on the very day the Fed hiked rates by the largest amount in 20 years?
Crude oil prices jumped more than $5 a barrel. Cotton prices posted new all-time historic highs of nearly $155.
Lean hog prices were sharply higher. Wheat prices jumped 31 cents a bushel, with soybeans picking up 10 cents.
Gold was up $13, silver gained 36 cents and copper rose 900 points. And the major commodity indexes were sharply higher with the Goldman Sachs index gaining a whopping 2,300 points.
Higher interest rates may be bearish, but that certainly was not seen with commodities, per se, the day the Fed hiked rates in an aggressive maneuver.
However, it is true and history shows clearly that higher interest rates “may take about a year to see any widespread impact,” according to Investopedia.
But the reason commodities, per se, did so well the day the Fed hiked rates is clear to me: Markets always worry more about today than tomorrow.
And today in the world of commodities, there are vast shortages and weather issues from one end of the globe to the other.
A stiff tailwind for inflation was announced May 6. The U.S economy added more jobs than expected in April due to an increasingly tight labor market despite surging inflation and fears of a slowdown in growth because of higher interest rates.
The U.S. labor market is quite strong as shown by the April Employment Report. For more than 75 years, economists embraced the Phillips curve that states inflation and unemployment have an inverse relationship.
Higher inflation is associated with job creation — lower unemployment — and vice versa. Thus, the April Employment Report showing more jobs created hints of even stronger inflationary pressures.
History shows the Fed usually gets what it wants, which is why you don’t fight them.
From thebalance.com: “‘Don’t fight the Fed’ is an investing mantra that suggests investors align their asset allocation with the interest rate actions taken by the Federal Reserve Board of Governors.”
CNBC quoted Fed Chair Jerome Powell as saying, “Inflation is much too high and we understand the hardship it is causing. We’re moving expeditiously to bring it back down. We’re strongly committed to restoring price stability.”
“That likely will mean, according to the chairman’s comments, multiple 50-basis point rate hikes ahead, though likely nothing more aggressive than that,” CNBC reported.
Powell did say, “the American economy is very strong and well-positioned to handle tighter monetary policy.” He added that he foresees a “soft or softish” landing for the economy despite tighter monetary policy.
There is no doubt the Fed will get what it wants. It wants lower inflation. However, it may take a year before inflation slows to the point the Fed is satisfied with its policy.
But between now and then, markets always worry about today before they worry about tomorrow. And today the economy is robust, inflation running hot with shortages of most commodities.
The war raging in Ukraine will impact grains and crude oil prices more than most understand. In such a bullish scenario, I cannot be bearish for commodities today.
Tomorrow is a different story.