2023-06-22 12:34:55 ET
Summary
- Rates may be on the cusp of a big move higher.
- The move higher in rates could be due to a surge in commodity prices.
- This would be the most unwelcome news for stocks.
Treasury yields are on the verge of making a big push higher as rates rise globally, driven by inflation that has been elevated, sticky, and slow to come down. This has caused global central banks to accelerate rate hikes in Canada, Australia, and England. On top of that, there are now clear signs that commodity inflation may be about to come back, and if that happens, then headline inflation is likely to take a turn higher in the US.
The commodity threat is why the Fed is so focused on core PCE because if the Fed can't get core PCE to come, then when commodity inflation returns, the headline inflation rate will begin to rise quite notably, and that will result in rates moving higher, and potentially even leave the Fed to have to raise rates higher than the most recent dot plot.
Rates May Rise Further
The 30-year Treasury rate is the most prominent part of the yield curve, suggesting that rates are going higher. The first point is that over the past 50 years, core PCE has always been lower than the 30-year Treasury rate; the current period is the first time that core PCE is not lower than the 30-year Treasury rate.
From a technical standpoint, the 30-year rate appears to have formed a bullish continuation pattern known as a cup-and-handle, and this would suggest that the 30-year rate pushes higher, and it could mean the 30-year climbs back to its October highs, which would take the 30-year rate to around the core PCE inflation rate. This pattern also is present in the 10-year Treasury rate, which suggests a move higher in rates is coming across the yield curve.
Commodity Inflation Making A Return?
The Bloomberg commodity index also is nearing a potential break out to the upside, and higher commodity prices are likely to push interest rates higher and probably contribute to inflation not coming down as quickly as the equity market has been pricing in.
Additionally, there's a similar bullish setup on oil prices rising, with an evident upward momentum on the relative strength index, and very close to breaking above a downtrend for the price. Falling oil prices have been a significant tailwind for disinflation and have helped to suppress headline inflation over the past year; a move higher in oil to $82 would undoubtedly blunt many of the disinflationary forces that oil has provided over the past few months.
It isn't much different in gasoline either, showing plenty of signs of consolidation and the potential for a big move higher in price. The main difference is that gasoline prices could add to inflation if it rises above $3.15 by the time it gets to around August.
Two of the most significant contributors to headline inflation rates falling could, at best, become a blunting tool to slowing the pace of disinflation or, worse, become additive to headline inflation as we move through the rest of 2023 on top of core inflation that has remained elevated.
It isn't just rising energy prices; wheat and corn are climbing and breaking long-term downtrends while the cost of Cattle continues to push higher and higher.
Even natural gas prices are very close to moving higher, with the relative strength index showing strong momentum to the upside and the price approaching a critical resistance level.
If we start seeing these commodities prices break out and push higher from current levels, they will likely become additive to inflation rates and the headline CPI reading. The year-over-year changes in oil prices are highly correlated to changes in year-over-year changes in the CPI.
Meanwhile, the Bloomberg commodity also highly correlates to the ISM manufacturing prices paid index. So if commodity prices are set to start rising again, it's likely to result in the ISM prices paid index rising.
The outlook in commodity prices appears to be very close to or already breaking higher and is likely why Treasury rates are very close to breaking out to the upside. This also is visible in the 10-yr real yield rate, which has been consolidating around 1.55% over the past couple of weeks while showing upward solid momentum, suggesting a break higher is likely coming for the 10-yr real rate.
A Big Problem For Equity Markets
The problem for stocks is that it comes at a time when valuation vs. real rates is extreme. The spread between the S&P 500 and the Nasdaq earnings yields and the 10-year real yield is at its narrowest point since the mid-2000s and well below their historical average of the past decade. If it's the case that nominal rates and actual rates rise, the spread between the equity markets earnings yield will either have to contract further, making stocks more expensive, or the earnings yields of the S&P 500 and the Nasdaq 100 will have to rise along with interest rates.
If it's the case that commodity prices surge, certain pockets of the equity market are likely to benefit, such as materials and the energy sector. However, the long-term duration growth sectors are likely to suffer, and due to the nature of the market caps of the broader indexes, equity markets would likely suffer as the rising rate would reduce the net present value of stocks overall.
Additionally, if the Fed must raise rates, should inflation reappear, it would likely tighten financial conditions, which would also be a negative for stocks.
As long as inflation remains an issue and rates are heading up, any rally in the equity market is not likely to last. At this point, inflation is not controlled and may be at a point where inflation is about to make an unexpected and unwelcome comeback.
For further details see:
Commodities And Rates Are On The Cusp Of Exploding Higher