U.S. Bond Market Week In Review: Why The Fed Is About To Make A Mistake In Raising Rates

Evan’s observations assume the effects of the commodity super-cycle slowdown are broader than simply the drop in oil prices. Commodity markets are confirming this analysis; there is currently a broad sell-off in the oil, metals and agricultural markets as shown in this chart from Bloomberg:

The story observes:

The index is made up of 33 different underlying commodity futures that can be put together into different subgroups. Three important ones are Brent crude oil (which in turn represents other liquid fuels like West Texas Intermediate crude and gasoline), crops and industrial metals. Altogether, they represent 70 percent of the index and offer a rough barometer of economic and industrial health: how much people are burning, eating and hammering.

All three are down in price so far this month compared to October, as is the index overall. That is rare: Looked at monthly since the start of 1991, it has only happened 15 percent of the time, clustered mostly around three periods: the Asian crisis of the late 1990s, the global financial crisis, and the past year or so.

Evans also notes the strong dollar’s impact; because commodities are priced in dollars, a higher dollar means lower commodity prices. And not just for oil, but the entire complex.This trend will only accelerate if the Fed raises rates. In summation, Evans, like Fed President Brainard, offers a nuanced and complex mix of events that he argues will keep inflation weak for a prolonged period of time. 

End Excerpt

I believe Brainard and Evans are correct.

Conclusion

There is just enough weakness in two of the long-leading indicators and one coincident indicator to, at minimum, give the Fed pause. And the drop in the entire commodity complex as a direct result of Chinese rebalancing is the primary reason for weak inflation. In that case, a rate hike will add to deflationary pressure: the dollar will rise, adding downward pressure to all commodity prices.  It is for these reasons that I believe a rate hike in the current environment is a mistake. 

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Disclosure: None

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad ...

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