2000issue C071-4
Build a four-market commodity overlay for inflation regime context
A historical screen ranked futures by how consistently they moved with 12-month CPI change, then summed 10-day percentage changes in crude oil, cotton, cattle, and copper. The overlay was meant to place a bond or stock view in a current inflation regime while official CPI still lagged collection.
- A commodity-to-inflation screen splits a 20-year sample into five four-year windows, averages each market's correlation with 12-month CPI change, and ranks consistency by the average absolute deviation of those five coefficients.
- Among 16 widely traded futures, crude oil, cotton, cattle, and copper sat toward high average correlation and low deviation and form the four-market basket.
- Summing 10-day percentage changes in those four markets and plotting that daily sum against Treasury bond futures builds a short-horizon inflation overlay.
- Official CPI releases can lag collection by weeks, so the coincidental overlay is meant to place a bond or stock view in a current inflation regime rather than wait for the printed report.
Put one trade inside an inflation regime
A single bond or stock idea can sit inside a current inflation regime instead of waiting on a CPI calendar. Official CPI releases can lag collection by weeks, so a coincidental commodity overlay is meant to place that view in the current regime rather than after the printed report.
The historical workflow first screened widely traded futures for consistent coincidental ties to 12-month CPI change. It then built a short-horizon overlay from crude oil, cotton, cattle, and copper.
How the commodity-to-inflation screen was built
A commodity-to-inflation screen can be built by splitting a 20-year sample into five four-year windows. In each window, record the market's correlation with 12-month CPI change.
Average those five coefficients for each market, then rank consistency by the average absolute deviation of the five coefficients. Markets that keep a high average correlation and a low deviation are the more consistent coincidental inflation ties.
Four markets that ranked high and consistent
Among 16 widely traded futures, the strongest and most consistent coincidental inflation ties sat toward high average correlation and low deviation.
Crude oil was near +0.56 with 0.19 deviation. Cotton was near +0.50 with 0.06 deviation. Cattle was near +0.46 with 0.14 deviation. Copper was near +0.47 with 0.28 deviation. Those four names become the overlay basket.
Early-window oil and heating-oil series used official or wholesale quotes before futures listed, which the study treated as a possible understatement of those energy-inflation coefficients.
Sum 10-day changes and plot them against bonds
A short-horizon inflation overlay can be constructed by summing 10-day percentage changes in crude oil, cotton, cattle, and copper and plotting that daily sum against Treasury bond futures.
That daily sum is the coincidental reading used to place a bond or stock view in a current inflation regime rather than wait for the printed CPI report.
A printed CPI can arrive after the tape has moved
In the June 1999 CPI episode, data collected through June 21 were released on July 15 showing unchanged inflation. Crude oil had already rallied about $2.50, or nearly 15%, after bottoming the day after collection ended.
The overlay is built for that gap between collection and release. It is meant to place a bond or stock view in a current inflation regime rather than wait for the printed report.
All readings on this track · 9 readings
- 1990Building index futures fair value from cash-and-carry
- 2000Build a four-market commodity overlay for inflation regime context
- 2010Softs stocks-to-use and semiannual event windows
- 2012Contango and credit risk in listed commodity and volatility wrappers
- 2014A cheap-looking long in volatility-index futures is a classroom, not a fear hedge
- 2015A wide Treasury calendar and the 2015 delivery gap
- 2015A 2015 forced unwind is not a commodity-regime verdict
- 2017Contango, carry, and contract choice in equity-index volatility futures
- 2018One commodity-index future, three classroom decisions