February 26, 2024

Commodity Insight: Fed or no Fed, I am hard to turn

The Federal Reserve left U.S. interest rates unchanged this month, waiting to see if the rapid rate hikes since March 2022 will finally push inflation down to their target of 2%. In late 2021, inflation rose to a 40-year high of 9.1%, but last month it was 3.7%.

The Fed also promised to hike rates one more time this year and keep rates higher for a longer period of time.

A few days before the Fed sat tight with rates, yields on the 30-year Treasury bond hit their highest levels in 13 years.

Yields on the 10-year Treasury notes hit their highest levels in 15 years. The debt markets have been collapsing, but the equity markets remain robust.

In the 1970s and early 1980s, when inflation was a problem, an accepted fact of life was that stocks follow the lead of bonds. Or, as bonds go, so go stocks.

Read this from Investopedia with a headline, “Intermarket relationships definition: Correlations between different asset classes.”

The article claims: “Generally, when inflation is high and volatile, stocks and bonds have a positive correlation. That is, their prices move in the same direction (downward). When inflation is low and stable, stocks and bonds tend to have a negative correlation. Investors should always bear in mind that other factors could affect an expected or established correlation.”

This week, before the Fed decision on monetary policy, Treasury bond prices fell to their lowest levels since April 2010. Back then, the Dow was approximately 11,250 compared to this week of 35,000.

In other words, T-bonds this week were back to where they were 13 years ago, but the Dow is 2.8 times higher than it was 13 years ago.

But, remember, Investopedia claims that “when inflation is high and volatile, stocks and bonds have a positive correlation. That is, their prices move in the same direction.”

However, Investopedia also stated, “investors should always bear in mind that other factors could affect an expected or established correlation.”

Imagine for a moment that stock prices were poised to follow the lead of bond prices that just kissed a 13-year low. That would mean the Dow, stocks per se, would drop 60% to catch up to the bond market.

I wonder if the real reason the Fed did not hike rates this month is because it knows that stocks tend to follow the lead of bonds.

The Fed would have far more pressing problems with stocks collapsing than with inflation being stubborn.

The Fed did say the U.S. economy is in good shape as job creation is slowing and higher rates are weighing on economic growth, keeping inflation from moving north.

And over the past 18 months, the Fed has hiked rates at the fastest clip in 40 years. Rates moved from near zero to no higher than 0.25% just before the outbreak of COVID to a high this week of 6% to 8%.

Greg McBride, the chief financial analyst for Bankrate, on Sept. 18 wrote: “This does not assure that we won’t see another interest rate increase in the months ahead. Inflation pressures are easing, broadly speaking, but remain well above desired levels with the risk of further increases in oil prices, so the Fed cannot yet declare victory.”

The recent rise with crude oil is a growing problem for the Fed. History does indeed show stocks follow the lead of bonds.

History also shows that commodities, per se, follow the lead of crude oil. Consider the following.

In May, a few months ago, crude oil prices were under $64 a barrel, but this week rose to $92 a barrel.

And a number of analysts are now calling for $100 crude sooner than later. One analyst is calling for $300 crude.

The Fed always gets what it wants. Hence, the old saw, “never fight the Fed.”

The Fed can hike rates higher and higher and destroy demand everywhere. But the Fed cannot create more crude oil.

Nor can the Fed create more cattle that hit historic highs this week. Nor can the Fed end the war in Ukraine, where grain flow is threatened.

Nor can the Fed control the weather, a wild card for crops where serious issues are surfacing in Argentina, Australia and Brazil.

Regardless of what the Fed does moving forward, I remain bullish on the food and energy markets.

On my desk is an old Scotch-Irish prayer that describes me clearly. It reads: “Lord, grant that I may always be right, for thou knowest I am hard to turn.”

I remain a bull regardless of the Fed. I have not changed my lean.