Canada Markets

The U.S. 10-year note has resumed its climb following a correction going into the U.S. Thanksgiving holiday. After peaking at 4.47% on Nov. 15, it fell to under 4.14% after the non-farm payroll report on Dec. 6. It has since moved back up to 4.30%, looking more all the time like the pullback (bounce in Treasury prices) was merely a correction in a bigger move. But why and what can be expected?

Investors tend to want a higher rate of return for one of two reasons. Either it is to overcome inflation, thereby maintaining a desired real rate of return, or because they perceive the risks to be elevated. Given recent Consumer Price Index (CPI) and Producer Price Index (PPI) reports, it clearly appears to be the former.

For this update, I will be referring to factors discussed in previous blogs found at https://www.dtnpf.com/…, https://www.dtnpf.com/… and https://www.dtnpf.com/…, as this ties the three together.

The latest CPI figures updated Dec. 11 were initially met with relief by the Treasury markets given all details were as expected. The headline number rose 0.3% month over month and 2.7% year over year. Core CPI rose 0.3% month over month and 3.3% year over year, also as expected. The problem is it still represented an increase in headline figures compared to last month (from 0.2% and 2.6%, respectively), suggesting inflation bottomed above the Federal Reserve's target of 2% and is now on the rise. The September print at 2.4% may very well mark the cycle low, considering the current 2.7% would be higher if not for the -3.2% energy offsetting factor. The fact that the core CPI has stalled for months now at 0.3% month over month with no sign of retreating is also concerning.

The PPI report out Dec. 12 was even more troubling. All measures were hotter than expected, suggesting June 2023 marked the bottom for the headline figure at 0.3%. The current headline number came out at 3% year over year versus 2.6% expected and 2.6% last month. By taking out the June 2024 high, it marks the largest year-over-year headline PPI reading since February 2023. Month-over-month readings were no better with the headline at 0.4% month over month, double expectations of 0.2%. Core PPI (less-volatile food and energy) had a similar pattern with gains of 3.4% year over year versus expectations of 3.2%.

Clearly there is little room to argue, inflation appears to have bottomed and turned higher prior to reaching the Fed's target of 2%. The fear now would be a repeat of the 1970s cycle when an apparent taming of inflation was followed by a much more problematic acceleration. As many would recall, the crushing interest rate increase required to bring it back under control had serious ramifications. The Fed has done what it can recently to make sure history doesn't repeat but now appears to be choosing risks to the labor market over the inflation battle by lowering rates despite the data.

The latest news on that front didn't help. Dec. 12 jobless claims came in at 242,000 compared to estimates of 220,000. Even the payroll report Dec. 6 had conflicting messages. The non-farm payroll version suggested more jobs added than expected while the separate household survey suggested much the opposite. It reported a loss of 355,000 jobs over the month, a little more consistent with the surprising increase in unemployment (4.2% versus 4.1% expected). If the household survey has some truth to it, that would certainly explain the Fed going ahead with a rate cut next week regardless of the recent inflation reports.

The Canadian unemployment rate unexpectedly jumping to 6.8% compared to expectations of 6.6% and last month's 6.5% in its November employment report led to a half-percent rate cut by the Bank of Canada on Dec. 11. The Swiss National Bank just cut a half percent when a quarter was expected, taking them down to a half percent remaining, and the European Central Bank cut a quarter point as expected. All indications are that the U.S. Federal Reserve will follow through with a quarter-point cut next week as planned.

Now what? As discussed in the Commitments of Traders blog, this is exactly the worst-case scenario that the commodity index traders are worried about: A Federal Reserve that has to downplay inflation at the most critical time -- early in the resumption of another potential run higher. If they (CIT) repeat their strategy from four years ago, they will be buying commodities as a hedge against inflation with relatively cheap grains and oilseeds a prime target. Besides watching for unexplainable strength in those markets, we will be monitoring the weekly supplemental report to track their actions.

Keep in mind that nobody wants to consider bullish news in bear markets and vice versa in bull markets. Should prices pick up, facts such as the major world corn exporting countries (Argentina, Brazil, Russia, South Africa and Ukraine) only have 7.99 million metric ton (mmt) of ending stocks compared to 15.06 mmt last year and 18.47 mmt in 2022-23 would be quite concerning as long as prices aren't falling. Or that major world wheat exporters (Argentina, Australia, Canada, European Union, Russia and Ukraine) only have ending stocks totaling 30.13 mmt compared to 39.88 mmt last year or 47.51 mmt in 2022-23. But why would a 36.6% drop in carryover in two years amongst world suppliers outside of the U.S. be a concern? The point is, there are lots of reasons for prices to rally if the market wants to look for them.

So, how do we market our production and manage operations if such a scenario is developing? Refreshing your 1970s history lesson would be a good start. Being aware of the potential for increased prices when developing marketing plans and being on the lookout for triggers. It may also be wise to keep an open mind about prices increasing for no apparent reason as outside investors buy commodities as a hedge against inflation. And, unfortunately, consider the impact higher interest rates may have on the operation should a repeat of that part of the cycle be seen -- along with strategies on how to mitigate the impact.

With that, keep in mind I'm always happy to get feedback along with any suggestions for future blogs.

Mitch Miller can be reached at mitchmiller.dtn@gmail.com

Follow him on social platform X @mgreymiller

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