The Tell: Metals’ slump says the 10-year Treasury yield has room to slide: Moody’s

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A precipitous drop in industrial metal prices over the past month could be flashing a bullish sign for bonds.

That’s based on the findings of John Lonski, head of capital markets research at Moody’s Analytics, who says the swoon in industrial metals could be a boon for bondholders as the Treasurys market has historically taken a cue from metals prices. Bond yields tend to fall when industrial metals come under pressure, but are slower to rise when metal values see an uptick. Debt prices rise when yields fall.

“As the yearly decline by the industrial metals price index deepens, the likelihood of an accompanying drop by the 10-year Treasury yield increase appreciably,” he said.

Lonski says that since 1987, there were 49 quarters when the three-month average for the Moody’s industrial metal prices index fell from a year earlier. Eighty six percent of those quarterly periods also saw a similar fall in the 10-year yield from a year earlier.

Moody’s index for base metal prices fell 12.2% in the past month, hitting its lowest level since last August. Over the same period, the 10-year Treasury note yield TMUBMUSD10Y, -0.52%   has shed 15 basis points to 2.834%, according to Tradeweb data. Bond prices move in the opposite direction of yields.


The plunge in metal prices have arrested their cyclical climb

It shouldn’t be a surprise that bond yields follow industrial commodities as both are governed by the dynamics of global growth.

When the world economy is booming, appetite for raw materials among manufacturers and builders will push prices for commodities higher. In the three decades up to 2017, the percent change in Moody’s industrial metals price index showed a positive correlation of 0.79 with the International Monetary Fund’s estimate of global growth, according to Lonski. A positive reading of 1.0 would be a perfect correlation, meaning the two move in the same direction.

At the same time, strong growth can spur inflation, which can wear away at the value of a bond’s fixed-interest payments, sending yields for U.S. debt higher.

Yet despite the fall in metal prices, inflation has been on the rise. The consumer price index accelerated to a 2.9% year-to-year pace in June.

Market participants, however, expect the burst of price pressures to be temporary, with many seeing the lack of wage pressures and a potential trade war weighing on inflation.

See: Why is the bond market shrugging off a six-year high in inflation?

Lonski’s finding that bond yields share a close relationship with metal prices isn’t new to investors. This correlation has been used more famously by bond guru Jeffrey Gundlach of DoubleLine Capital who said the 10-year U.S. government bond yield closely tracks the ratio between copper and gold prices, which has fallen over the past month.

Much of the drop in the copper-to-gold ratio has been driven by the slump in copper values. September copper futures HGU8, -0.04% have tumbled 15% in the past month. Analysts say the weakness in the ubiquitous metal shows investors may be turning their back on the narrative of global synchronized growth which enjoyed a surge of popularity earlier this year.

“It has to be asked what it says about the global economic outlook when this cyclically-sensitive metal has collapsed,” said David Rosenberg, chief economist for Gluskin Sheff, in a note.

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