Posted by on March 13, 2017 3:11 pm
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Categories: Business Central Banks Commodity Deflator Economy Index Inflation Personal consumption expenditures price index Reflation Structure US Federal Reserve Volatility

Thanks to commodities, Bloomberg’s Mark Cudmore warns that the Fed meeting is more likely to be the death knell for reflation trades rather than mark their moment of victory.

This week is set to provide confirmation that we’re in the midst of a true tightening cycle in the U.S., with rate hikes in consecutive quarters for the first time since 2006.

10-year Treasury yields hover just below the two-year high, but I don’t see them breaking higher in an environment where commodity prices are plunging.

Oil was just the latest victim last week, with prices falling the most in four months. The broader Bloomberg Commodity Index topped out a month ago, with everything from metals to agricultural goods turning sharply lower since then.

This undermines the reflation trade in three ways.

  1. Most directly, it’s hard for inflation to keep accelerating when input prices are slumping.
  2. It also suggests that real demand is not growing as quickly as hoped, which provides caution on economic optimism.
  3. Finally, while cheaper commodity prices are a long-term positive for economic growth, the more immediate wealth/portfolio effect is negative.

Price data from the U.S. this month has validated the suspicion that inflation is not rising as fast as forecast, with the PCE deflator coming in below expectations.

This isn’t an environment that supports much higher long- term yields. Add in the context that speculative short positions in Treasuries remain near record levels and it appears to be a market ripe for a squeeze.

Furthermore, as Bloomberg’s Richard Breslow concludes:

The abrupt about-face by the Fed has dealt a severe blow to the efficacy of forward guidance.

Markets will understandably assume that central banks are now using commentary as a tactical device to control the moment rather than a way of describing a strategic plan based on long-term forecasts.

It means we are in for a lot more false steps, conspiracy theories and greater volatility

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