Commodities: an immaculate asset for an immaculate disinflation?
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Commodities: an immaculate asset for an immaculate disinflation?
A recent survey indicates that 21% of investors have no intention of investing in commodities1. We have argued that commodities are a strong strategic asset that offer great diversification benefits, inflation hedging and a long-term risk premium2. However, we acknowledge that many people see commodities as a short-term tactical instrument3. Looking down the barrel at a global economy that’s likely to continue decelerating in 2024, combined with the perception that commodities are a tactical asset, it’s unsurprising that close to a fifth of investors are refraining from the asset class. However, evidence points to real commodity prices generally rising in soft landings. Many investors could be missing an opportunity by sitting on the sidelines.
What is a soft landing?
Market consensus seems to be coalescing around a soft economic landing or an immaculate disinflation in 2024.
However, there are no official definitions of either term. The National Bureau of Economic Research (NBER), which dates recessions doesn’t have a definition for a soft landing. Many economists consider a recession with a small increase in unemployment as soft. The immaculate disinflation concept is similar in that inflation is subdued by an economic deceleration without a spike in unemployment. Such soft landings or immaculate disinflations are ideal from central bankers’ perspectives as they are associated with enough economic cooling to dampen price pressures without inflicting widespread economic pain.
Alan Greenspan, Federal Reserve (Fed) chairman between 1987 and 2005, is often accredited with creating a quintessential soft landing in the mid-1990s. In early 1994 the US economy was in its third year of recovery following the 1990-91 recession. By February 1994, the unemployment rate was falling rapidly, down from 7.8% to 6.6%. CPI inflation was 2.8%, and the federal funds rate was around 3%. With the economy growing and unemployment shrinking rapidly, the Fed was concerned about a potential pick-up of inflation and decided to raise rates pre-emptively. In 1994, the Fed raised rates seven times, doubling the federal funds rate from 3% to 6%. It then cut interest rates, three times in 1995 when it saw the economy softening more than required to keep inflation from rising.
Commodities in a soft landing
To analyse soft landings, we use the work of Princeton economist Alan Blinder4, a former Fed vice chair. He considers soft landings as a period when gross domestic product (GDP) declines by less than 1% and the NBER doesn’t declare a recession after at least a year of a Fed hiking cycle. We analyse the performance of commodity prices one year prior to and after the final Fed fund rate hike in each of these episodes.
In the chart below, we show real commodity prices (deflated by the US Consumer Price Index), indexed to 1 at the final rate hike in the soft landing period. What is clear is that not every soft landing is the same, but on average, commodity prices are soft for the 5 months prior to the last rate hike and then rise thereafter.
In 2000 and 1995 commodity prices rose prior to and after the last rate hike. And in 1984, commodity prices fell before and after the last rate hike. The two examples from the 1960s – 1966 and 1969 – fit the average profile of softening a few months before the last rate hike and rising after it.
The main takeaway is that in 4 out of the 5 soft landings, commodity prices were up 5 months after the last rate hike.
Source: Bloomberg, WisdomTree. November 1965 – July 2001. Monthly data. Commodity price (Bloomberg Commodity Total Return Index) deflated by the US Consumer Price Index, indexed to 1 on the month of the final rate hike in the cycle. Legend label indicates the year of last rate hike in the cycle. Historical performance is not an indication of future performance and any investments may go down in value.
Are we in a soft landing now?
As we argue in What Will “Higher for Longer” Actually Mean?, major central banks around the world are getting ready for the next stage of monetary policy. The Fed, which is arguably the leader of the pack, has left rates unchanged since August 2023. US inflation pressures appear to be declining in a meaningful way while US unemployment was very low at 3.7% in November 2023. In fact, while unemployment had been on a slow rising trend from 3.4% in January 2023 to 3.9% in October 2023, it surprisingly dipped in November. While the dip may be accounted for by idiosyncratic factors such as the resolution of strikes and extra hiring by government and healthcare, the University of Michigan survey of consumers also climbed to a four month high, pointing to positive sentiment that is inconsistent with the beginning of a hard landing. Moreover the survey showed inflation expectations cooling despite underlying strength in the labour market. While soft landings are difficult to achieve, current conditions appear supportive of one.
Sources
1 WisdomTree, Censuswide. Pan-Europe Professional Investor Survey Research, Survey of 803 professional investors across Europe, conducted during August 2023.
2 See The Case for Investing in Broad Commodities, November 2021
3 Although as we argue in Myth-busting: top 6 misconceptions about commodities, commodities aren’t just tactical instruments.
4 Landings, Soft and Hard: The Federal Reserve, 1965–2022, By Alan S. Binder, Journal of Economic Perspectives—Volume 37, Number 1—Winter 2023—Pages 101–120.
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