Inflation Reacceleration: Recent CPI data from the U.S. confirms a trend towards inflation reacceleration, complicating the Federal Reserve's efforts under Jerome Powell to reach the 2% inflation target, writes analyst Ulrik Simmelholt of Steno Research.
A comprehensive analysis shows that nearly all components of the global inflation drivers' basket, except for supply chain pressures, have increased throughout 2024. This trend suggests a headline inflation rate year-over-year at approximately 4.5%.
Currency and Commodity Markets Response: The market has reacted to inflation fears with notable shifts in short-term interest rates and foreign exchange markets, where the U.S. dollar has gained strength. Interestingly, the traditional correlation between a strong USD and weak commodity prices appears to be changing, with both asset classes gaining simultaneously, indicating a potential shift in market dynamics.
Commodities and U.S. Export Position: The U.S. has emerged as the world's largest oil exporter, influencing the dynamics between crude oil prices and the USD.
Notably, even commodities like copper have shown gains alongside the USD, a sign that might suggest a broader "melt-up" in markets. This development raises questions about the traditional economic correlations and their future trajectories.
Yield Curve and Asset Allocation Implications: Despite the broad strength in commodities, this has not translated into expected movements in the long end of the yield curve, which historical post-pandemic relationships suggest should be higher.
Current levels of the 10-year U.S. Treasury yield suggest an underestimation of inflation expectations, which poses risks for asset allocation strategies.
Energy Sector and Geopolitical Impacts: U.S. crude stock levels indicate that prices should be much higher, a situation that complicates any potential Western efforts to impose strict energy sanctions on countries like Iran and Russia.
The risk of high oil prices rekindling inflationary pressures similar to those seen in 2022 remains a significant concern.
European Energy Crisis and Industrial Output: In Europe, Germany's energy crisis exemplified by companies like ThyssenKrupp cutting back production due to rising energy costs and competition from Asian imports, underscores the broader challenges facing industrial output in the region.
This situation is exacerbated by Germany's phased-out nuclear energy and reliance on Russian gas, posing long-term strategic challenges.
Conclusion and Investment Insights: The ongoing reflation narrative, driven by rising commodity prices and shifting market dynamics, suggests that broader commodities might offer more intriguing investment opportunities than oil alone.
Investors are advised to monitor these developments closely, especially the long end of the yield curve, for potential implications on asset allocation.