CAMS Weekly View from the Corner – Week ending 3/19/21
March 22, 2021
Strewn throughout our 2021 editions we have shared the difficulties of the bond market overall. One of several tributaries of the bond market’s challenges is the price inflation backdrop. Prices across the economy have been rising notably and in some cases outright rapidly.
A notable nemesis of a fixed return investment is price inflation. A bond offers a fixed or stated interest rate when it is issued whereby it will pay a certain interest rate until its maturity date.
Once a bond is issued and then trades in the open market the stated interest rate continues to be paid by the issuer to the current holder of the bond. After the bond is issued bond market participants takeover the “interest rate” by how the bond trades in the market place.
Keeping it simple and focusing on the price inflation backdrop solely; if the price inflation rate is rising and bond market participants feel there should be a higher interest rate for the bond they will place downward pressure on the price of the bond in the open market by selling said bond.
As the price moves lower the new holder purchases the bond at a lower price than what it was issued at.
While the stated interest rate payment from the issuer remains the same, the new owner receives a higher effective interest rate being they purchased the bond at a lower price than its price at issuance.
With the above, bond market participants will continue to increase the effective interest rate (known as yields) by placing downward pressure on the bond price by increased selling to offset the rising inflation.
The bottom line is if price inflation is increasing bond participants will want a higher interest payment to compensate for the rising price inflation and the above is how they do it.
This edition is meant to have an investor/citizen flavor to it as we focus on price inflation generally and how that can play out in the bond market. Taken from the bond market, as interest rise, this then plays a role in stock market pricing. Rising interest rates can place downside pressure on stock prices.
Drilling down into the price inflation story a bit and speaking to the citizen/consumer in all of us, we are seeing a notable, multi-year behavior change in food commodities.
The above view covers eight years in length and depicts the price behavior of numerous agricultural commodities. Major components of the above vehicle include Corn, Sugar, Coffee, Live Cattle and Soybeans to name a few.
The significance of the price behavior is the strong upside breakout of prices relative to the well established, multi-year downtrend depicted by the black line. The red arrow highlights the strong and quick upward thrust of prices.
Historically, when any market takes out a well established multi-year downtrend behavior and does so with ease, it speaks to a trend change worthy of attention. This and other pricing trends have certainly gotten the bond market’s attention.
As mentioned we share this for the citizen/consumer in all of us as well. We can expect higher food prices coming our way unless the above price trend turns south in a hurry.
We doubt this in light of its historical significance. Market’s rarely have such a violent upward thrust whereby it ends a multi-year downtrend story-line only to quickly turn tail and go right back down. This strength offers it has some staying power.
If these price trends continue to rise from here the bond market may demand even higher interest rates to compensate for the rising price inflation. If this continues as an on-going trend it will continue to get the stock market’s attention as interest rates rise throughout the bond market landscape.
We are watching prices throughout markets closely for additional signs of direction as they feedback loop via their inter-connective relationship to one another.
I wish you well…
Director, Market Research & Portfolio Analysis
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
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