Interest Rates Ignore Commodity Price Inflation

By Tom Burnett CFA
Commodity prices, as measured by the Bloomberg Commodity Index, have risen by 21.3% in 2021 (through July 21, Wall Street Journal). Most of the price pressures derive from the recovery in the energy sector which was badly mauled by the Covid-19 outbreak and the economic slowdown in 2020. Crude oil prices are up 45% this year. Natural gas is now up 56% from the end of 2020. The S/P 500 Energy ETF (“XLE”) has risen 30% this year. Prices for crops have also risen as the global economies recover from the lockdowns initiated in 2020 to offset the spread of the Covid-19 virus. Gold prices, however, are actually lower by 5% this year, suggesting that the commodity price pressures will not lead to an overall inflation increase. While consumer prices rose by 5.4% in June, compared to a year ago (the highest year-over-year rate since 2008), the fixed-income markets have shrugged off the data and, recently, rates have moved lower.
Looking at the yield on the ten-year Treasury note, we see rates moving lower from the 1.74% level of March 2021. The rate is currently 1.29%. Similarly, the rate on the 30-year bond has declined from 2.45% in March to 1.93% in the current market. Most observers see the rate declines as a signal that the economic recovery may be peaking as new Covid virus strains appear which could lead to another phase of lockdowns and economic stagnation. Emoloyment growth has also slowed down recently which suggests that the growth prospects may be turning weaker. Investors seem to be saying that the commodity price inflation pressures are limited to those sectors where increased production will lead to lower prices without a big impact on the overall economy. In addition, the Federal Reserve remains committed to a lower interest rate environment until the economic recovery and accompanying jobs growth return to pre-Covid levels. The Fed has been supporting this policy with aggressive purchases of Treasury bonds and mortgage-backed securities and investors must remain vigilant in their observation of the current pro-growth Fed policies since a change in direction could lead to higher rates and lower bond prices.
Tom Burnett CFA is Director of Research