foxex: Signs of Deflation?

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Thursday, April 16, 2020

1. Interest rates approach new lows as stocks inch higher

2. Soft futures falling

3. Lower rates hurting growers?

Market Moves

Stocks and bond prices both moved higher on the day as interest rates moved towards recent lows. Lower interest rates seem like a good thing, but is it possible that they represent some looming difficulty ahead? While the S&P 500 index (SPX) closed higher by about one-half percent, the Nasdaq 100 index (NDX) closed nearly two percent higher today. The 10-year Treasury note index fell to .61% sending the iShares' 20-year Treasury Index Fund (TLT) another 1.14% higher as rates flirt with negative territory. The good news about lower rates is that the cost of mortgages, and borrowing in general, goes down. The bad news is that when it becomes too much of a good thing, it has unintended consequences.

For now, one area where the COVID-19 pandemic has brought increased efficiency is that the work-at-home economy is rewarding those companies that can make their products and services function well for independent agents. The chart below compares three companies thriving as more workers come to rely on tools for productivity in the home office. Microsoft (MSFT), Amazon (AMZN), and Zoom Communications (ZM) are conspicuous beneficiaries of the current conditions. It will be interesting to see what kind of impact the current business climate has had on the balance sheets of these three. With earnings season upon us, we won't have long to wait before we find out.

Soft Futures Falling

Grocery store stocks like Kroger (KR) and Sprouts Farmers Markets (SFM) are on the rise. Everyone knows their local grocer has had a run on several items over the past month, so it would seem obvious that those businesses are doing well. Therefore the suppliers to such grocers should also be doing well, right? Not so fast.

The chart below displays a comparison between Invesco's DeutcheBank Agriculture Fund ETF (DBA), and several commodities (using the futures spot price for each of these), including Sugar, Wheat, Corn, Live Cattle (Beef), Cocoa, Soybeans, and Lean Hogs (Bacon). The aforementioned ETF tracks an average of these futures contracts, so it makes for a good benchmark against which to compare all of them.

What gets the attention of any chart watcher when looking at this chart is that these commodities have all drifted lower since February 20, the day when markets began to panic in earnest over effects of the COVID-19 virus. Unlike stocks, they haven't shown any particular kind of bounce. Why should that be? If food is the one commodity that everyone is retrenching towards right now (whether grocery hoarding or stress eating), why are food prices actually falling at the producer level? The answer, surprisingly, may have something to do with falling interest rates.

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Lower Rates Hurting Growers?

The chart below directly compares the 10-year Treasury note yield index (TNX) with Invesco's Agriculture index fund (DBA) and measures a three-month rolling correlation coefficient between them. The purpose of this measure is simply to determine whether these prices, mathematically, tend to move together. Over the past three years, the correlation coefficient has spent most of its time in positive territory. On the chart itself it is easy to see that both of these price movements are trending lower.

So the observation begs the question of how lower interest rates could be bad for agricultural producers. After all, aren't growers who can pay less interest likely to make more profit? Perhaps, but perhaps also they are able to produce more product, creating the potential for unneeded additional supply.

If the market demands all that is produced, that's no problem. But in a world where demand begins to shrink for various reasons, additional supply becomes a troublesome thing for producers. This matches what chart watchers have been observing in the oil markets over the past several years as well. This strong move lower in all commodities implies signs that a nasty condition is creeping towards us. One that Fed officials hate to see, let alone discuss: deflation.

The Bottom Line

Stock prices and bond prices both rose as investors watched interest rates creep closer to zero. The impact of these falling rates are great for people who want to apply for a mortgage refinance, but they may create bigger problems as commodity prices are beginning to demonstrate.