Posted on Leave a comment

Interest Rates And Commodities – Interest Rates, Inflation, And Commodities, Oh My!

  •   
  •   
  •   
  •   
  •   
  •   
  •  

Introduction

 

 

Interest rates are one of the most important economic variables.

Changes in interest rates impact all major asset classes such as stocks, bonds, currencies, and commodities.

In this lesson, we’ll focus on the relationship between interest rates and commodities – among other asset classes.

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Types Of Interest Rates

 

 

Let’s start by exploring interest rates to learn how they’re determined and what causes them to fluctuate.

There are two types of interest rates that most investors pay attention to – short-term and long-term.

Short-Term Interest Rates

 

 

Financial institutions use short term rates to determine the rates you get in savings accounts, money market accounts, credit cards, and personal loans.

In most developed countries, short term rates are set by the country’s central bank.

In the US, the central bank is the Federal Reserve.

The Federal Reserve, or Fed, meets regularly, usually about every six weeks, and determines where short term interest rates should be.

 

 

The Fed makes this decision based on a number of economic factors including growth, labor and inflation.

The Fed adjusts rates in hopes of steering the economy in the right direction.

When the economy is sluggish, or even in a recession, the Fed lowers rates in an effort to stimulate growth and motivate investors to buy assets like stock and commodities.

 

 

Conversely, when the economy is growing too fast, the Fed raises short term rates in an effort to curb spending.

Now that you know how the Fed determines short term rates, lets discuss how long terms rates are established.

 

Long-Term Interest Rates

 

 

The Fed’s short term rates play a role in determining long term interest rates.

But the biggest factor is the bond market – specifically, the treasury bond market. Of particular interest to most investors is the interest rate of the 10-year treasury note.

The interest rate of the 10-year note, or more specifically its yield, is determined by institutional bond investors.

These investors buy and sell large amounts of treasury bonds based on factors similar to what the Fed considers – namely, economic growth, employment, and inflation.

 

 

While bond investors consider these economic variables, along with many others, the most important tends to be inflation.

Inflation is the rise in prices of goods and services. The rising prices of goods and services erode purchasing power, which means $1 today is worth more than $1 tomorrow.

Inflation is problematic for bond investors because bonds have fixed income payments attached to them. These fixed payments are worth less if inflation is rising.

 

 

So if inflation rises, investors in the bond market tend to sell bonds, pushing long term interest rates higher.

While inflation is usually bad for bond prices, it is historically good for commodity prices.

In fact, commodities sometimes perform exceptionally well during periods of rising inflation.

That’s because commodities such as crude oil, natural gas, gold and copper, among others have real world value.

Commodities serve purposes like fueling vehicles or heating a home.

 

 

These uses for commodities don’t change during periods of inflation – as people still need to fuel their cars and heat their homes regardless of price.

Because of this, commodities tend to hold their values during periods of inflation. And that’s why some investors buy commodities in anticipation of inflation.

How To Detect The Signs Of Inflation

 

 

So how can you anticipate inflation?

Most governments regularly publish inflation reports.

In the US, the reports are the consumer price index, or CPI, and produce price index, or PPI.

The CPI measures inflation at the consumer level, and the PPI measures inflation at the business level.

These reports come out once a month and bond investors use this information to make buying and selling decisions.

If inflation rates rise, bond investors usually sell bonds.

 

 

Conversely if they fall, bond investors would typically buy.

Another way to anticipate inflation is to follow the yields of the 10-year treasury note.

One way to do this is to watch an index that tracks the yield of the 10-year note, such as TNX (10-Year Treasury Note Index).

When TNX is falling, it means investors are not worried about inflation.

But when TNX is rising, it means investors are worried about inflation – as this may be a good time to further evaluate commodities.

 

Quick Recap

 

Types Of Interest Rates

 

1.) Short-Term Interest Rates

2.) Long-Term Interest Rates

 

Short-Terms Interest Rates

 

  • Financial institutions use short term rates to determine the rates you get in savings accounts, money market accounts, credit cards, and personal loans
  • In most developed countries, short term rates are set by the country’s central bank
  • In the US, the central bank is the Federal Reserve
  • The Federal Reserve, or Fed, meets regularly, usually about every six weeks, and determines where short term interest rates should be
  • The Fed makes this decision based on a number of economic factors including growth, labor and inflation
  • The Fed adjusts rates in hopes of steering the economy in the right direction
  • When the economy is sluggish, or even in a recession, the Fed lowers rates in an effort to stimulate growth and motivate investors to buy assets like stock and commodities
  • Conversely, when the economy is growing too fast, the Fed raises short term rates in an effort to curb spending

 

Long-Term Interest Rates

 

  • The Fed’s short term rates play a role in determining long term interest rates
  • But the biggest factor is the bond market – specifically, the treasury bond market. Of particular interest to most investors is the interest rate of the 10-year treasury note
  • The interest rate of the 10-year note, or more specifically its yield, is determined by institutional bond investors
  • These investors buy and sell large amounts of treasury bonds based on factors similar to what the Fed considers – namely, economic growth, employment, and inflation
  • While bond investors consider these economic variables, along with many others, the most important tends to be inflation

 

 

Inflation, Interest Rates & The Bond Market

 

  • Inflation is problematic for bond investors because bonds have fixed income payments attached to them. These fixed payments are worth less if inflation is rising
  • So if inflation rises, investors in the bond market tend to sell bonds, pushing long term interest rates higher
  • If inflation rates rise, bond investors usually sell bonds
  • Conversely if they fall, bond investors would typically buy

 

Inflation, Interest Rates & The Futures (Commodity) Market

 

  • While inflation is usually bad for bond prices, it is historically good for commodity prices
  • In fact, commodities sometimes perform exceptionally well during periods of rising inflation
  • That’s because commodities such as crude oil, natural gas, gold and copper, among others have real world value
  • Commodities serve purposes like fueling vehicles or heating a home
  • These uses for commodities don’t change during periods of inflation – as people still need to fuel their cars and heat their homes regardless of price
  • Because of this, commodities tend to hold their values during periods of inflation. And that’s why some investors buy commodities in anticipation of inflation

 

Detecting Factors Of Inflation

 

There are TWO ways you can measure inflation……

1.) Inflation Reports That Are Published By The Government

 

  • In the US, the reports are the consumer price index, or CPI, and produce price index, or PPI
  • The CPI measures inflation at the consumer level, and the PPI measures inflation at the business level
  • These reports come out once a month and bond investors use this information to make buying and selling decisions

 

2.) Follow The Yields Of The 10-Year Treasury Note

 

  • One way to do this is to watch an index that tracks the yield of the 10-year note, such as TNX (10-Year Treasury Note Index)
  • When TNX is falling, it means investors are not worried about inflation
  • But when TNX is rising, it means investors are worried about inflation – as this may be a good time to further evaluate commodities

 

 

 

Well this has been a cross-over of your bond and futures knowledge that you have acquired here at Invest In Wall Street.

The biggest takeaway that you should grasp at the end of this lesson is how interest rates play a crucial role in not just one, but in ALL asset classes. Different asset classes will experience different effects – and some will have similar after effects – almost like a see-saw.

An underlying theme that we have discussed in this lesson, and many other lessons, is inflation – and the impact they have on the value on several asset classes – but for the sake of simplicity, we are two just focus on these two asset classes.

When interest rates are rising, the bond yields also rise, and the value of bonds decrease in value – causing bond investors to sell. And if interest rates fall, bond yield rise, and the value of bonds increase in value, causing bond investors to buy.

The opposite effect takes place when it comes to the commodities (futures) market. In the eye of rising interest rates, the price or value of commodities increases, causing investors to invest more in commodities (oil, gold, silver, wheat, ect.) – as this is one of the asset classes that can withstand the effects of inflation.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

  •  
  •  
  •  
  •  
  •  
  •  
  •  
Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.