Bullish Commodities Feeding Into Inflation View, Charts Show

(Bloomberg) -- Rising commodity prices are feeding through to expectations for quickening inflation. There are signs that further gains may be in store for both.

A weaker dollar, U.S. corporate tax cuts and signs of improving global economic growth have helped boost raw materials. The Bloomberg Commodity Index reached an 11-month high on Tuesday, and the underlying pace of U.S. inflation unexpectedly accelerated in December. While inflation has held below the Federal Reserve’s target, advancing commodities are one factor that show why policy makers are expected to continue raising interest rates this year.

“The price rises we have seen in 2017 and we expect to see continuing in 2018 will begin to feed through into headline inflation over the course of the year,” Paul Gait, an analyst at Sanford C. Bernstein Ltd. in London, said in an email Jan. 18. “Years of deflation from the commodities complex look like it is coming to an end.”

The following charts explore the outlook for commodities and inflation.

1. Rising Expectations

The spread between yields on nominal and inflation-linked U.S. Treasury debt, known as the breakeven inflation rate, is viewed as investors’ outlook for price pressures. The measure touched an eight-month low in June, which was also a trough for the Bloomberg Commodity Index. Both gauges have risen since, with the breakeven rate now near the highest in more than three years.

2. Golden Rule

As better-than-expected economic data boost investor optimism over the outlook for base-metals demand, copper, often seen as a barometer of global economic health, has been surging. The price of the red metal relative to gold reached a three-year high late last month. “Rising copper-gold ratio points to improving global growth and leads to upward price pressures,” George Davis, chief technical strategist at RBC Dominion Securities Inc., said in a note to clients Jan. 18.

The International Monetary Fund raised its forecast for global expansion to the fastest rate since 2011, when the world was bouncing back from the financial crisis.

3. Feedback Loop

Expectations for faster inflation may also feed back into the outlook for commodity prices. For every 1 percent annual increase in the U.S. consumer price index since 1991, copper jumped more than 17 percent, second only to energy, which gained over 28 percent, according to a correlation analysis of total returns on commodity indexes compiled by Bloomberg Intelligence. The S&P 500 Index of equities advanced 2.5 percent, while Treasuries maturing in at least 20 years lost 2 percent.

Measuring that sensitivity is something called “inflation beta.” The correlation of any one commodity to rising consumer prices can be volatile. For example, copper fell in 2011 even as inflation accelerated. But over time, there are patterns to the relationship that make holding raw materials a good bet when inflation is accelerating, said Mike McGlone, analyst at Bloomberg Intelligence in New York.

To contact the reporter on this story: Susanne Barton in New York at swalker33@bloomberg.net.

To contact the editors responsible for this story: James Attwood at jattwood3@bloomberg.net, Joe Richter

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