Why commodities may shine in an era of stagflation
By Ole Hansen, Head of Commodity Strategy at Saxo
Saxo recently adjusted its 2024 outlook for the US economy from non-recession to a milder form of stagflation, termed 'stagflation light', categorised by sluggish growth paired with persistant inflation. Historically, during stagflation periods, specific commodities attract heightened attention.
In a recent analysis, Saxo's Chief Investment Officer, Steen Jacobsen, outlined why we have adjusted our 2024 outlook for the US economy from non-recession to a milder form of stagflation, termed 'stagflation light', categorized by sluggish growth paired with persistent inflation. Later analyses delved into the potential repercussions of stagflation on equities, bonds (here and here), and forex. This shift primarily arises from the notable surge in real interest rates, making the funding costs for the US almost insurmountably high, as shown by the recent downgrade of the US credit rating by Fitch.
Additionally, we've seen a significant escalation in consumption costs with interest rates, encompassing everything from credit cards and new vehicles to mortgages, are currently twice the long-term average, nearing punitive levels. Moreover, there's a noticeable deceleration in job data and spending, even as inflation persists, especially in the domains of wages and energy.
This combination of low growth and moderately high inflation is indicative of stagflation, and if materialized it will confirm a view that the Federal Reserve and central banks around the world in general are fighting a losing battle against stubbornly high inflation and that further action will damage economic growth while doing nothing to tame the sticky nature of prices pressure. It leads us to believe that the US Federal Reserve will cut rates before the 2% average inflation target has been reached, leading the FOMC to upgrade its target to 3%, a development that will force a repricing of future inflation expectations, and with that a commodity supportive lowering of real yields.
Historically, during stagflation periods, specific commodities attract heightened attention due to several factors:
- Inflation Hedge: Traditional commodities like gold and silver are perceived as safeguards against inflation. As inflation erodes the value of paper currency, tangible assets, particularly precious metals, often keep their worth through rising demand and prices.
- Diversification: Amidst a stagflation backdrop where standard financial assets like stocks might underperform, investors often look to diversify their holdings. Commodities offer an asset class with minimal correlation, potentially enhancing portfolio performance during such times.
- Interest Rates: Central banks may be reluctant to hike interest rates in a stagflation setting for fear of hampering growth further. Moreover, a weaker dollar can make dollar-denominated commodities more affordable for non-dollar-based buyers, potentially amplifying demand and prices.
- Real Returns: In a climate where nominal returns on conventional financial assets are diminished by inflation, tangible assets like commodities can provide positive real returns. This is particularly pronounced when commodity prices surge due to supply limitations or strong demand.
Further reading : click here
