Intermarket Analysis: Profiting from Global Market Relationships

CHAPTER 9

Falling Dollar During 2002 Boosts Commodities

COMMODITIES INFLATE

The previous chapter mentioned the Fed’s sudden concern about deflation in May, 2003, and the U.S. government’s abandonment of its strong dollar policy. The plan was to sacrifice the dollar in an attempt to boost prices. By the time the Fed noticed that prices were falling, commodity markets had already been rallying for over a year. A lot of that had to do with the falling dollar. The rise in commodities, however, did not have the normal impact on bonds. As mentioned earlier, one of the major intermarket relationships that had changed since 1998 was the link between bonds and stocks. During the second half of 2002, another key intermarket relationship changed: the link between bonds and commodities.

Rising commodity prices during the second half of 2002 should have produced lower bond prices and higher bond yields. They did not. One possible explanation for the decoupling of bond yields and commodity prices is the presence of global deflationary trends. U.S. rates are linked to global rates, which tend to rise and fall together. With Japan still mired in a deflationary decline, global interest rates continued to drop together. This global deflationary influence helps explain why bond yields did not follow commodity prices to a higher level during the second half of 2002. Falling stock prices also kept a lid on interest rates. A closer examination of the individual commodity markets that led the CRB ...