Since Joe Biden won the U.S. presidential election, the market has been on a tear chasing cyclicals, the reflation trade. We saw a massive switch out of growth stocks and into value, as the latter has been a decade old underperformer, so calling the turn has been enticing. As the rotation carried through till the end of the year, every sell side house, right on cue, started upgrading their numbers for value oriented sectors, and jumped on the inflation band wagon. After all who could blame them as Biden constantly spoke about $2 trillion stimulus bill and another $3 trillion infrastructure bill this spring. With trillions being used casually these days, it is no wonder that the dollar and most fiat currencies are getting devalued every single day. The Fed may try to deny inflation is "transitory" but they use a measure that has been very conveniently modified to exclude all the things that really matter. This gives them the perfect excuse to keep doing what they do best, print more!
Inflation is evident across the board as breakeven inflation rates suggest that US 10-year bond yields should be valued somewhere closer to 2%-2.5%. That is a worrying thought in and of itself, as if it were to materialize, especially the pace at which it materializes, the market would not be able to handle it as we saw the last few weeks, despite the Fed claiming that this signals better economic growth. One thing is clear with this spending spree, commodities come back in vogue given the massive inflation implications as broad money supply grows, one needs to own hard assets. The infrastructure push makes commodities like copper, iron ore, and steel in more demand given their respective industrial uses. To top that off, China had massively boosted its credit growth all of 2020 to get its economy out of a pandemic induced slowdown. After all they had to meet their 6%-6.5% annual GDP growth target. And manage they did, as it was the only country in the world to end the year at +2.3% but with credit growth up ~ 13% year over year!
China has massively levered their balance sheet, but that rate of change of credit growth, called the credit impulse, has been slowing down since December and through the start of this year. What is going on? China is taking its foot off the pedal for now. Whether it is seasonally or just general de-leveraging remains to be seen. But this means a big tailwind that saw copper, iron ore and all rally hard is now taking a breather. There is six-month lag between when the Chinese credit impulse slows to the price of the major Bloomberg Commodity Index, so the fact that is has been falling over the past few weeks should come as no surprise as one of the world's largest buyers has pulled back a bit, for now. The excitement and rush into commodities helped it move away from its own fundamentals given this speculative inflow helped it break away from its correlation vs. the dollar. The most consensual trade out there has been to be short the dollar, which is supportive for commodities. Despite all the deficit spending priced in, the dollar has been stubbornly strong this past month, and is looking to break higher just as China slows down.
The market is awash with liquidity with follow on inflation. Whether this leads to the type of GDP growth the Fed thinks is debatable. One thing is for certain, inflation is here to stay with us, but it is important to choose the right commodity to reflect that view as opposed to the entire basket, especially when China is done stimulating. For now, the market correlations are close to one - there is either indiscriminate buying or selling, but soon each commodity will move to reflect its own demand/supply dynamics taking into account their respective inventory balances. At the end of the day, commodities are all about whether they are in surplus or deficit given the demand/supply projections, so choose wisely.