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Will a Second Rate Hike Slow the Commodity Run or Speed It Up?

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Federal Reserve’s first rate hike dragged down commodity prices

In December 2015, the Federal Reserve raised the interest rate for the first time in a decade. It dragged down the movement of commodity prices. The commodity index (DBC) fell almost 13% from December 16, 2015, to January 20, 2016. It showed that commodities are inversely correlated with interest rate movements.

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Commodities are negatively correlated with interest rates

The WTI (West Texas Intermediate) crude futures and the PowerShares DB Commodity Tracking ETF (DBC) both have negative correlations with interest rates. Between May 4, 2010, and March 11, 2016, WTI crude oil and DBC both had a negative correlation of 43.3% and 33%, respectively, with the Fed fund rates.

Another interest rate hike will strengthen the dollar

This correlation simply implies that a second rate hike will pressure commodity prices, as commodities are denominated in the US dollar (UUP) (USDU). Moreover, a rate hike by the Federal Reserve would strengthen the movement of the dollar, which could cause commodity prices to fall to lower levels.

As we’ve already seen, the rate cut in China has also added strength to the recent commodity rally. However, we have to watch speculations about whether a further stimulus in China (FXI) (YINN) and an increase in domestic demand in China will come true or not.

The graph above shows the movement of DBC and WTI crude oil with the federal fund rate since 2010. Emerging markets (EEM) (VWO) such as Brazil (EWZ), Russia (RSX), and China have been significantly affected due to commodity price fluctuations this year. If there’s a second rate hike from the Federal Reserve, we can expect huge fluctuations in these markets.

In the next part, we’ll look at some avenues for commodity investments.

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