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Indications of Deflationary Pressures.

Posted on March 09, 2016

Indications of Deflationary Pressures.

Posted on March 09, 2016

Commodities and U.S. Treasury yields move parallel to one another indicating deflationary pressures.

The Past vs. The Present

As I’m reading John J. Murphy’s book titled, “Intermarket Technical Analysis” it brought to light an interesting relationship I wanted to discuss given its relevancy to today’s economy. History shows that commodities move in tandem with long-term US Treasury Bond yields and opposite bond prices. The key reason is inflation. The rise and fall of prices on commodities indicates changes from rising or falling inflation. During a recession demand for goods along with money diminishes resulting in lower prices and rates. Which is where we currently are today. The chart below shows the CRB Index (commodity Index) vs. the 10 Yr. U.S. Treasury Yield from 1973 to 1987. You can see that the CRB Index leads the 10 Yr. U.S. Treasury yield by about a year.

The important take-away for studying this intermarket relationship is what they say about where the market may be heading, i.e. Inflation, disinflation, or deflation? The next page I illustrate the present parallel relationship between DJP (commodities) and the 10 Yr. U.S. Treasury yield (TNX). [see image CRB to 10 Yr.].

As you can see both commodities and yields have been in a long-term bearish trend since 2011. This is important to be aware of in order to indicate a higher or lower likelihood of a bullish or bearish stock market trend to come.

The next chart, I illustrate the present inverse relationship between the coinciding ETFs for commodities (DJP) and the 10 Yr. U.S. Treasury Bond (IEF). [see image '10 Yr. Yield to DJP' and '10 Yr. Price to DJP']. The inverse relationship is apparent, noticeably since the summer of 2011 and 2014. The vast spread between the two since the summer of 2014 is important to note.

If the Fed is expected to raise interest rates gradually in 2016 this would put downward pressure on bond prices and one may suspect that commodities would rise…or would they? Raising rates would be in-line with the US Dollar getting stronger but this would lead Commodities lower still. Thus, I contend that raising rates would push bond prices lower but perhaps not to the degree to lift commodities substantially higher. Therefore, Commodities, from a technical stand-point and a fundamental stand-point don’t look to be inflationary, but instead deflationary. But, if the Fed chooses not to raise rates what would occur? That’s for another discussion and more importantly, commodities are the leading indicator at the moment so we’ll keep our focus here.

Now, we can’t talk about the price of goods without the US Dollar either, which also moves opposite commodity prices. Below, [see the image 'Dollar vs. many others"] the USD is in black which is trending in a bullish pattern against three other currencies of our major trading partners; the Euro FXE, the Yen FXY, the British Pound FXB. This adds conviction to the deflationary period we may be entering as commodities, yields and the dollar currently confirm one another.

The trend is your friend,

Jos. G.


Image of 'CRB Index vs. 10-year Treasuries' from "Intermarket Techincal Analysis" by John J Murphy. Page 21