Perspective: Commentary for March 12

By: Arlan Suderman, Chief Commodities Economist

Sun, 12 Mar 2023, 23:41

Perspective: Commentary

Arlan Suderman

Chief Commodities Economist

March 12 - There’s been a lot of speculation about what impact the developments of the past 72 hours will have on the markets when they open tonight, going into the week. Keep in mind that’s all it is – speculation. There are facts and there are perceptions, and in the markets, perception is reality. I fully expect the Federal Reserve to go to great lengths to back up depositor accounts, as they are quickly jumping in to do. I expect the Biden Administration to back up the Fed’s actions with support as well, along with the FDIC. No Administration wants to be known for the time when the banks failed. We live in an era when government promises whatever is necessary, and then makes sure the money gets printed to pay for it. That’s a longer-term key to this story. At what point does the Fed jump back into its dovish ways, adding more fuel to the inflation risks for the short-term security of the banking sector? That said, the government / FDIC / Federal Reserve can do everything right, and we could still have a fear-driven market that creates a self-fulfilling market risk. Fear is a powerful force in the markets, whether it is grounded in fact or not, and there will be plenty of “experts” on Twitter spreading fear.

Look for volatility to be the name of the game this week, with the commodities very vulnerable to headline risk. That would have been true anyway this week. The bank failure reports simply add to that headline risk. In some cases, that may mean funds liquidating positions in the commodities to cover losses in other markets. They may be long in some commodities and short in others. Mixed in with that will be the headline risk of this week’s economic data. It will be a big week of data releases, including the consumer price index, producer price index, and retail sales, along with a number of other reports. The Fed may be in the mood to cool its rate hikes to ease the pressure on these regional banks, which could turn the focus more to inflation again if this week’s CPI and PPI numbers, along with retail sales, continue to come in hot. The 10-year correlation between the StoneX commodity index and the 5-Year Breakeven Inflation Rate tends to run between 0.80 and 0.82, which is a relatively strong correlation, although not a guarantee of future behavior. Fund managers tend to shift money into commodities in times when they have rising inflation expectations and pull it out when more worried about a recession. There has been up to a two-month lag in the commodities responding to changes in the 5-Year Breakeven Inflation Index. It started to turn higher several weeks ago. One possible scenario would be if perceptions of a more dovish Fed develop, allowing more focus on inflation risks, that we could see more money move into the broader commodity sector. We should know a lot more about the Fed’s changing views after they meat in 10 days, but that can seem like an eternity in the markets.

The bottom line is that I’m less worried about the mechanics of the risks, based on expectations that regulators and policymakers will back the banks, and more concerned about the potential fallout from fear spreading through the markets. The number of economic data releases this week simply add to those fears. I’ve observed that it is difficult for any commodity to sustain a rally when the VIX is above 30, reflecting elevated fear levels on Wall Street. So, keep an eye on the VIX. An individual commodity can sustain a rally when the VIX is above 30, but history suggests that it must have a strong story to do so. As such, look for those commodities with the strongest story to perform the best.

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