Monetary policy uncertainty, positions of traders and changes in commodity futures prices

• Date: 01 March 2018
• Published date: 01 March 2018
• DOI: http://doi.org/10.1111/eufm.12150
• Author: Nikolay Gospodinov,Ibrahim Jamali

DOI: 10.1111/eufm.12150

ORIGINAL ARTICLE

Monetary policy uncertainty, positions of traders

and changes in commodity futures prices

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Nikolay Gospodinov

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Ibrahim Jamali

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1

Financial Economist and Policy

Adviser, Research Department, Federal

Reserve Bank of Atlanta, 1000 Peachtree

Street NE, Atlanta, GA 30309-4470

Email: Nikolay.Gospodinov@atl.frb.org

2

Associate Professor, Department of

Finance, Accounting and Managerial

Economics, Olayan School of Business,

American University of Beirut, Beirut

1107 2020, P.O. Box 11-0236, Riad El-

Solh Street, Lebanon

Email: ij08@aub.edu.lb

Abstract

This paper examines the sensitivity of commodity price

changes to monetary policy uncertainty. We find evidence that

the response of commodity price changes hinges on the sign of

the monetary policy shock, the level of monetary policy

uncertainty as well as a recession dummy. Uncertainty

associated with negative monetary policy shocks leads to a

decrease in commodity prices and excess speculative activity.

The results from estimating an asset pricing model suggest

that monetary policy uncertainty appears not to be a priced

risk factor in the cross-section of commodity price changes.

KEYWORDS

commodity prices, monetary policy uncertainty, futures data, Fama-

Macbeth regression, asset pricing model, futures basis, positions of

traders, speculators

JEL CLASSIFICATION

G13, G14, G17

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INTRODUCTION

The surge in commodity prices in the mid-2000s has led to a renewed interest among policymakers,

investors and academics in identifying the factors that drive commodity prices. While the inflationary

consequences of commodity price increases and the adverse effect of oil price shocks on economic

*The authors thank the Editor and two anonymous referees for numerous helpful comments and insightful suggestions that

greatly improved the contents and presentation of the paper. They are also grateful to the participants in the 2016 Financial

Management Association conference in Las Vegas, Nevada for helpful discussions and comments. The second author

gratefully acknowledges financial support from the American University of Beirut's University Research Board. The views

expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal

Reserve System.

Eur Financ Manag. 2018;24:239–260. wileyonlinelibrary.com/journal/eufm © 2017 John Wiley & Sons, Ltd.

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activity are widely studied by academics

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and articulated by policymakers (Bernanke, 2008), the

factors driving commodity price fluctuations have proved to be more difficult to uncover. However,

understanding the behavior of commodity prices is of key importance in designing economic policies

that limit their impact on real economic activity and inflation. Factors that have been identified to drive

the dynamics of spot commodity prices include convenience yields (Gibson & Schwartz, 1990;

Gospodinov & Ng, 2013; Schwartz & Smith, 2000), exchange rates (Chen, Rogoff & Rossi, 2010) and

interest rates (Frankel, 2008; Schwartz, 1997).

In this paper, we explore the effect of monetary policy uncertainty on individual commodity prices

as well as on commodity price indexes across time and in the cross-section. In view of the increasing

financialization of commodities (Cheng & Xiong, 2014; Gorton & Rouwenhorst, 2006; Tang & Xiong,

2012), we argue and provide empirical evidence that Monetary Policy Uncertainty (MPU) is an

important determinant of commodity risk premiums. Using data on the positions of traders for

individual commodities, we also uncover a novel empirical relationship between excessive speculative

activity, measured using Working (1960)'s Tindex, and MPU.

Despite the voluminous literature on the effect of monetary policy changes on commo dity prices

(Basistha & Kurov, 2015; Frankel, 2008) and other financial variables such as inte rest rates (Kuttner,

2001), exchange rates (Fatum & Scholnick, 2008) and stock retu rns (Bernanke & Kuttner, 2005), the

response of commodity prices to MPU has not been thoroughly investigate d in the literature. This is

unfortunate given the important role that uncertainty shocks play in deter mining real activity

(Bekaert & Hoerova, 2014; Bloom, 2009; Jurado, Ludvi gson & Ng, 2015), the equity risk premium

(Anderson, Ghysels & Juergens, 2009; Zhou, 2017) and bond risk premium s (Buraschi, Carnelli &

Whelan, 2013).

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Changes in interest rates can, according to Frankel (2008), exert an impact on commodity prices

through the inventories and speculation channels as well as by changing the incentives for extracting

commodities.

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The tight link between the Federal funds target rate, the Fed's main policy instrument,

and various short-term interest rates, implies that monetary policy actions can also affect commodity

prices through the aforementioned channel. Given that our measure of MPU comprises information on

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Despite the widely held view that commodity price increases pass-through to inflation, Gospodinov and Ng (2013) were

the first to provide evidence of a robust empirical relationship between commodity prices and inflation.

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We should note at the outset that various definitions of economic uncertainty are employed in existing research. Bloom

(2009) uses the Chicago Board Option Exchange (CBOE)'s S&P 500 option-implied volatility index (VIX) to measure

economic uncertainty. Bekaert and Hoerova (2014) refine Bloom (2009)'s approach by decomposing the VIX into

uncertainty, proxied for using stock market volatility, and a variance risk premium. Jurado et al. (2015) define time-varying

economic uncertainty as the common component extracted from a large panel of unexpected changes in macroeconomic

variables. Anderson et al. (2009) measure uncertainty as the degree of disagreement among professional forecasters while

Buraschi et al. (2013) combine a Taylor rule estimate of the Federal funds rate with survey forecasts to measure MPU.

Baker, Bloom, and Davis (2016) devise an economic policy uncertainty index which comprises measures of uncertainty

relating to fiscal, monetary and regulatory actions. Given that our interest centers specifically on examining the effect of

MPU on commodity prices, we opt not to employ the existing measures of economic uncertainty. We discuss the reasons

we opt not to use the uncertainty measures discussed before as well as the advantages of our measure of MPU in greater

detail in section 2.3.

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More specifically, Frankel (2008) argues that an increase in the interest rate increases firms’costs of carrying inventories

and entices speculators to reallocate their portfolios. Following an interest rate increase, speculators would increase their

holdings of Treasury bills, which become more attractive due to the higher interest rates, and decrease the share of

commodities (or commodity futures contracts) in their portfolios. In addition, an increase in interest rate would increase the

incentive to extract resources due to the increased opportunity cost of delaying extraction.

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