Perspective: Mid-Day Commentary for October 6

By: Arlan Suderman, Chief Commodities Economist

Thu, 06 Oct 2022, 16:30

Perspective: Midday Commentary

Arlan Suderman

Chief Commodities Economist

October 6 - Economic worries headline trade on Wall Street today, as stocks slip lower and the VIX trades near 30. The dollar index is trading strong near 112.2, while yields on 10-year Treasuries trade near 3.81%. Crude oil prices are modestly higher, while the grain and oilseed markets are broadly under pressure today. OPEC+'s decision to slash its output quotas by 2 million barrels per day (2%) provides support for energy, while the grain and oilseed markets are largely trading recession worries again today.

The tide is shifting again on Wall Street. Traders again are focused on economic risks of current monetary policy leanings - both here and overseas. We started the week with traders focused on "peak tightening" ideas that the Federal Reserve and other global central banks would yield to market pressures, and begin to ease monetary tightening. Fed fund futures even priced in expectations that we would start to see interest rate cuts early next year. Today those rate cut ideas are being pushed back to late next year, after Fed members speaking at various events doubled-down on their conviction that rates need to continue to climb until inflation is tackled. Fed tightening necessitates that many other global central banks need to tighten as well. Foreign exchange reserves in many countries are shrinking as they try to defend the strength of their currencies to keep up with the strong dollar. Global credit risks are increasing as developing countries with large amounts of dollar-denominated debt struggle to originate enough greenbacks to make debt payments.

Is the Fed wrong to be doing what it's doing? The Fed is absolutely correct that inflation that gets engrained into an economy is more destructive than what we want to see here in the States. As such, it should have started this path a year earlier than it did when it would have been easier to manage. But now that we're here, the Fed is committed to the right principles. What we don't know though is, what's the correct pace for shrinking the balance sheet? That may be a more important question than the Fed's increase in its benchmark short-term rate. We're in unchartered territory now, and the Fed is having to figure it out as we go. Experts are created with experience, and they're getting their experience now. That has risks. The graphic below shows the five-year breakeven inflation rate over the past decade, which is the market's perception of average inflation over the next five years. It peaked in June, and has been trending lower, but it may be on the verge of turning higher again if inflation remains elevated. I post it against our StoneX Commodity Index to show the strong correlation over time. Money tends to flow into the broader commodity sector when fund managers have elevated inflation expectations, and flow out when the opposite is true, which is the current scenario. That creates headwinds for commodities, necessitating a stronger story to sustain a move higher against those headwinds.

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