Commodity rallies driving up risk of inflation

The rise in treasury bond yields has been the main cause for the recent fluctuations in US stock markets.

If you take a closer look, you will find the most affected stocks were last year's market favorites, namely new-economy stocks, whereas traditional stocks continued to perform well, as seen from the Dow Jones' cumulative rise of 2.9 percent since the start of 2021 compared to the Nasdaq's paltry gain of 0.25 percent.

This shows that the upsurge in new-economy stocks has come to an end. After all, there were over-expectations for most of the new-economy stocks, and when the market starts to believe that the economy is returning to normal, the valuations of these stocks will naturally return to more normal levels.

However, there are some factors that investors have overlooked.

Last year, central banks across the world rolled out quantitative easing and that, along with various government stimulus packages, led to huge amounts of cash being injected into the stock markets. This was not only unprecedented, but also distorted the markets.

Under these conditions, investors could not find any good prospects while looking for investment avenues and so they pumped a lot of cash into new-economic assets such as internet shares and cryptocurrencies that were being chased by the market, as they saw these assets as safe havens.

But with the global economy starting to recover, the rush towards safe havens has decreased and money is now returning to traditional assets. And as money flows back to traditional assets, energy, raw materials and other products will naturally become the object of investor enthusiasm, and so their overall performance this year has been good.

The CRB index of futures contracts - which covers energy, metals, agricultural products, animal products and soft commodities - has soared more than 15 percent so far this year.

This means the performance of energy and other commodity prices this year has been far better than the three major US stock indexes. However, this may add to global inflationary pressures and also put further pressure on rising bond yields in the future.

Therefore, even if central banks do not believe that global inflationary pressures are serious enough to raise rates this year, investors should not be too optimistic, because inflationary pressures could suddenly pick up in the second half of the year, forcing central banks to act.

Of course, central banks still have an excuse that commodity prices are volatile, and as long as core inflation, excluding food and energy, remains subdued, they can afford not to change monetary policy.

But if commodity prices continue to rise, factory costs will inevitably rise, and producer prices will eventually rise too. So core inflation will be affected and start to rise - and this means there is still chance that central banks will adjust monetary policy this year.

As a result, bond interest rates will by no means peak at the current level. The only way to make them fall is for central banks to increase their purchases of bonds again.

But this will only provide temporary relief, and since investors have returned to commodity markets, a rise in inflation is inevitable. And when inflation remains, at the same time, there will be more money flowing into commodity markets.

So investors should be ready to face a resurgence in inflation and also beware of mutations in central bank policies while paying attention to the risk of inflation turning into a stagflation crisis.

Andrew Wong is chairman and CEO of Anli Securities