Inflation Has Bonds and Commodities Trading Hand-In-Hand Again

Inflation Has Bonds and Commodities Trading Hand-In-Hand Again

Prices of commodities from oil to metals to food are rising to the point where they’re starting to trade in line with the bond market as central banks attempt to tackle inflation. 

Inflation Has Bonds and Commodities Trading Hand-In-Hand Again

The Fed plans to raise rates even faster than expected to tackle inflation, according to the minutes from its most recent meeting that were released Wednesday. The market is now pricing in an 80% possibility of a rate hike in March. Fed funds contracts and eurodollars, which serve as hedges against interest-rate increases, are pricing in just shy of four rate increases this year, more than the central bank indicated in its latest dot plot. The hawkish tone spooked equity investors, as the S&P 500 Index sank nearly 2% on Wednesday afternoon following the release of the FOMC minutes. Commodities, however, ended the session higher. 

Part of this is due to the underlying economy, which is growing faster than expected. Yields and commodities are usually the first assets to price that in. But commodities are also serving as an inflation hedge. After all, it’s increases in oil, metals, food and other raw materials that are driving up global consumer prices. 

“Oil and copper are the best hedges against inflation, not gold. Gold’s a lousy inflation hedge,” said Jeff Currie, global head of commodities at Goldman Sachs. “The best place to be right now, particularly given the Fed pivot, is commodities.”

Investors still need to be wary of the bear case for commodities relative to the bond market. Real yields have been deeply negative. And that’s offered a reason to seek returns in riskier assets, namely commodities like oil. But eventually inflation will abate and real yields will catch up, at which point commodities are likely to lose some of their momentum as the market adjusts its appetite for risk.

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