By Rom Badilla, CFA, Bondsquawk
Copper which is used in many facets of industrial production and is a gauge of global economic activity has declined recently. Since the end of the quarter, copper has tanked by slightly more than 13 percent to 330.80. More importantly, copper has diverged from inflation expectations which is the yield differential between U.S. Treasury 10-Year nominal yields and U.S. Treasury Inflation Protected Securities (TIPS). If copper either continues to decline or maintains its current level and the correlation holds to its historical norm, then inflation expectations should decline with a drop in U.S. Treasury nominal yields. In other words, higher quality bonds could trade even higher.
Furthermore, this decline in inflation expectations could give Ben Bernanke and the Federal Reserve the green light to embark on another round of balance sheet expansion in Quantitative Easing. While past policy action has usually coincided with lower levels of inflation expectation (and of course signs of weaker economic weakness), the tea leaves suggest that Fed action might be right around the corner if the current trend continues. Stay Tuned.
Bond Trading – Copper & Inflation Expectations