If the 2008 crisis is any guide, expect rising tariffs to boost commodities

This article is written exclusively for Investing.com

  • The bond market is already moving
  • 2 reasons why higher interest rates often weigh on commodity prices
  • 3 reasons why this time is different
  • A sharp decline is likely.
  • Buy the Bottom of the Wave: The DBC ETF

In early 2020, as the global pandemic gripped markets across asset classes, lockdowns created conditions that pushed commodity prices to multi-year lows. Prices for energy, metals, agricultural and industrial commodities plummeted, but the sale was short-lived.

Central banks have pushed interest rates to artificially low levels, using every tool in their monetary policy toolbox to stabilize the global financial system. Governments have rolled out stimulus packages for displaced workers and businesses and have spent fortunes developing vaccines and treatments. The cost of the pandemic was unprecedented and it planted inflationary seeds that began to sprout in the second half of 2020.

Inflation spiraled out of control in 2021, but blaming the economic situation on “temporary” factors slowed down the application of the harsh remedy needed to stop the inflation spiral. In November and December 2021, the Fed got a disclosure, realizing that inflation was structural, it turned to a more bellicose approach to monetary policy. However, the central bank did not end quantitative easing until early March 2022, simultaneously raising the Fed Funds rate from 0% to 8.5%, the highest level in more than four decades, and rising 11.2%.

Inflation was bullish for commodity prices, pushing them from a 2020 low to a multi-year high — and in some cases to an all-time high in 2021 and early 2022. With the Fed poised to take tough action, the commodities much closer to the highs than the lows. Inflation and rising interest rates are not the only problems facing the commodity asset class in early May 2022. The first major war in Europe since World War II has caused significant distortions in the fundamental equations of many commodity markets.

The bond market is already moving

The Federal Reserve will struggle to keep up with the bond futures market. On May 4, the FOMC raised short-term federal funds rates by 50 basis points, with further hikes expected in the coming months. A balance sheet reduction program will affect yields further down the yield curve, pushing them higher, but the market will set medium and long-term interest rates based on bond supply and demand.

Meanwhile, the bond market has been in a downward trend since mid-2021.

Source: Barchart

The chart shows the decline in US Treasury bond futures, which hit their latest low of 138-14 on April 20. The first level of technical support is at the lowest level of 136-16 as of October 2018.

The Fed Funds rate was raised from 0.75% to 1.00% on May 4, and many more rate hikes will be needed to keep pace with the bond futures market. In addition, with the March CPI and PPI at their highest levels since the early 1980s, the central bank is lagging far behind the inflation curve, with negative real interest rates.

2 Reasons why higher interest rates often weigh on commodity prices

Rising US interest rates tend to weigh on commodity prices because they increase the cost of holding inventories. In an environment of rising interest rates, consumers of commodities tend to buy their daily needs and pass higher prices on to retail consumers.

Rising interest rates also increase the currency’s value against other global reserve currencies.

Dollar Index Long Term

Source: Barchart

The US Dollar Index chart shows the currency reached 103.95 last week, just 0.01 above its March 2020 high, the highest level for the dollar in two decades since 2002.

The US dollar is the world’s reserve currency and the price mechanism for most commodities. A higher dollar tends to weigh on commodity prices as they rise in other currencies. The remedy for rising prices is high prices as consumers seek alternatives or limit their purchases, which weighs on aggregate demand.

In recent weeks, we have seen commodity prices fall from multi-year or historic highs. {Crude oil fell more than $130 a barrel and fell $2,072 to the $1,860 level. {It fell from just over $5 a pound to the $4.20 level. Most commodities adjusted for rising interest rates and a stronger US dollar.

3 reasons why this time is different

Rising interest rates and the US dollar are generally bearish for the commodities asset class. However, 2022 is anything but an ordinary period in history. Three factors could cause interest and exchange rates to fall in the coming weeks and months:

War in Ukraine, sanctions against Russia and retaliation cause supply disruptions affecting prices for asset class commodities

The “no borders” alliance between China and Russia creates an ideological split between the world’s nuclear powers, with the United States and Europe on the other side. With the United States and China on opposite sides of the ideological divide, tensions between the world’s two largest economies are fueling financial conflict.

Pandemic-induced supply chain bottlenecks and war-induced logistical challenges hamper the transportation of goods from producers to consumers, creating shortages in some regions and surpluses in others.

Meanwhile, the war and the drastic change in the geopolitical landscape have created other factors fueling global inflationary pressures. Russia recently stated that a gram of gold returned to 5,000 rubles as part of a return to a gold standard. If China follows suit, it will have major consequences for the global financial system. Saudi Arabia and Nigeria discuss the sale of crude oil to China for payment in , and Russia demands that European energy consumers pay for their fossil fuels in . These changes threaten the US dollar’s position as the world’s reserve currency, which would weigh on the dollar’s value. The dollar index measures the value of the dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. However, it does not measure the purchasing power of the dollar, which has declined along with all other fiat currencies.

Risk of a sharp downturn

As the Fed hiked rates by 50 basis points, negative data from the , which saw the indicator fall 1.4%, threatens stagflation, higher prices and lower economic activity. Stagflation puts the central bank in a difficult position, as higher interest rates could further choke economic growth. While we may see some spontaneous sales after the Fed meeting, the war in Ukraine causing price disruptions, the declining US dollar and general bullish trends in commodity prices could add a lot of volatility as the market digests the FOMC’s first significant aggressive decision in years.

The Fed is caught between its highest inflation in more than 40 years and a slowing economy. The central bank will remember 2021 as a missed opportunity to tackle inflation when it fell asleep at the wheel. In May 2022, the situation is much more complicated because the war in Ukraine and the ideological split are far more important to the global economy than US interest rates.

Buy the dip: study the DBC ETF

I think any further significant drop in commodity prices will be a buying opportunity. If the 2008 financial crisis is a model for the global pandemic of 2020, commodity prices continued to rise until 2011, three years later. We may only be in the midst of the post-pandemic commodities rally driven by central bank liquidity, government stimulus and the late response from the Fed, which did not hesitate to tighten lending when the opportunity came.

Moreover, liquidity levels and stimulus measures were much higher in 2020 and 2021 than in 2008 and 2009 and the world has not experienced the first major war in Europe since the Second World War, which causes significant changes in the fundamentals of supply and demand for all goods. The change in US energy policy in early 2021 will only complicate matters as it returns OPEC and Russia to power over fossil fuels, putting their relationship at the expense of US relations, the United States and Europe with the world’s leading oil companies. and gas producers is strengthened.

I continue to favor the commodity asset class. I think the current correction and the potential for lower prices from rising US rates and the dollar will create an attractive buying opportunity.

The Invesco DB Commodity Index Tracking Fund (NYSE:) is a liquid and diversified commodity-based ETF with an energy weighting. At just over $28 a share, DBC had more than $4.439 billion in assets under management. This ETF averages more than 4.59 million shares daily and charges a management fee of 0.87%.


Source: Barchart

The chart shows that DBC fell from $10.41 per share in March 2020 to its most recent high of $28.75 on April 18. At $28.07 per share, the ETF is nearing its peak. In 2008, DBC reached a record high of $46.63 per share. I expect the DBC to continue its bottom-up and top-down path in the coming months. Any substantial correction could be a golden buying opportunity for this product which is moving up and down with commodity prices.

The Fed may want to tackle inflation, but geopolitical events take center stage. The US central bank has no resources to deal with the ideological split that will fuel inflationary pressures.

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