Strategy Note /

Inverted yield curve is positive for commodities

  • The yield curve inverted on on 13 June, but this may not necessarily signal a recession

  • The last three cases of the US 2y Treasury yielding more than the 10y have been positive for commodities

  • Food prices, in particular, are poised for a strong rally

Inverted yield curve is positive for commodities
Nirgunan Tiruchelvam
Nirgunan Tiruchelvam

Head of Consumers Equity Research

Tellimer Research
16 June 2022
Published by

A story that took place in 500 BC could guide investors this week. Croesus, King of Lydia (a region in modern Turkey), consulted the Oracle of Delphi before deciding whether to wage war on Persia. The Oracle told Croesus that "he would destroy a great empire", which he took to mean that his kingdom would prevail. In fact, the army due for destruction was his own, and Persia duly wiped out Lydia.

Today’s equivalent of that advice from the Oracle of Delphi is the US yield curve, the inversion of which is viewed as a prelude to recessions. Since 1970, every inversion of the yield curve has been followed by a US recession within 12-14 months.

On 13 June, the yield curve inverted, with the US 2-year Treasury yielding more than the 10-year. This was the first time since April that such an inversion has taken place and is only the third such occasion since the global financial crisis of 2008.

US yield curve inversion and recession

However, this time around, a recession may not be certain – those looking carefully at the auguries will note that the inversion does not extend to the 30-year Treasury note. The curve is effectively a 'V', which provides some solace for those who are worried about recession – this week's inversion is unlike the other instances. 

Commodity prices may rally in the face of negative yields and trade disruption

What we think is worth noting is that the last three instances of the US 10-year yield falling below the 2-year yield (in 1998, 2001 and 2007) have been followed by two-year commodity rallies:

  • In the two years that followed the inversions of the yield curve in February 2000 and July 2006, the Bloomberg Commodity Index rose 12%.

  • In the two years that followed the inversion in August 2019, the index rose 24% in the next two years.

US Yield Curve (2Y 10Y) vs Bloomberg Commodity Index

This time around, we believe commodity prices could be due for a rally, for three reasons:

  1. The negative real yields for shorter-dated bonds have reduced the carrying cost of commodities. Commodity traders are facing a relatively low real cost of capital.

  2. Commodity players have reduced their capital expenditure since the rout of 2014. Investment by oil & gas companies fell by 52% between 2014 and 2020. Capex in the copper industry dropped by more than one-third in the same period.

  3. Covid has completely disrupted the commodity market, particularly soft commodities. The US is the mainstay of the world grain market, including soybean, corn and wheat. Several countries have imposed punitive tariffs on soybean and corn and corn prices have fallen below the cost of production.  

In short, the inversion of the yield curve reinforces the bull case for commodities. We have noted that food prices are poised to rise further due to tight supply/demand factors and several soft commodities, such as palm oil, look ripe for a further spike.