March 5 – Stock futures pulled back overnight ahead of key economic data to be released this week, as well as ahead of several public appearances of members of the Federal Open Market Committee. The VIX continues to trade near 14 this morning, while the dollar index is trading near 103.9. Yields on 10-year Treasuries hit a fresh three-week low overnight, as they are trading near 4.17%, while yields on 2-year Treasuries are trading near 4.58%. Crude oil prices are more than 1% lower this morning on disappointment in Chinese economic reforms emerging from central planners, while the grain and oilseed complex was mostly weaker as well.
China’s annual working report on economic objectives proved disappointing to observers, leading to speculation that government leaders either do not understand the scope of the economic problems at hand, or that they do not know how to fix the problems, leading to a no-confidence vote by the markets. The Chinese government set its growth target at 5% for the current year, targeting the urban jobless rate at 5.5%, with the inflation mandate at 3%. It put its targeted deficit rate at 3% of gross domestic product, down from 3.8% last year, and below market expectations of 3.5 – 4.0%. This would suggest lower emphasis on stimulus programs than what was anticipated by observers. Special purpose bonds used to fund major projects were pegged at 390 billion yuan ($54 billion), up just 10 billion yuan from the previous year. A separate special issue treasury bond issue of 1 trillion yuan was included, but analysts felt that the overall plan lacked the boldness needed to restore confidence in the Chinese consumer, while not specifically addressing problems in the property sector.
The property sector remains the primary concern for the Chinese economy, following Evergrande’s failure. China’s Country Garden Holdings saw its housing sales fall to a multi-month low in February, which was down 85% year-on-year. Furthermore, Chinese realty firm Vanke is reported to be facing liquidity problems in repaying overseas bonds. This raises questions about whether the government’s plans are sufficient to prevent the property sector problems from further hurting the overall Chinese economy? Instead, China put an emphasis on NEV auto production, as well as accelerating biological production. The move comes at a time when both Europe and the United States are taking steps to restrict electric vehicles from coming from China. This is expected to increase trade tensions between China and the United States, elevating the risks that those tensions could further impact commodity imports.
China is stocking up on commodities. It’s building reserves of what it considers essential commodities. That may be nothing more than reflective of a desire to have a larger reserve, or it may reflect preparation for possible conflict with the West in the months / years ahead. It spent the past year building reserves of soybeans, while it has also at times appeared to be building crude oil reserves as well. Now it is importing large quantities of corn and grain sorghum, even though our private sources believe that last year’s corn crop was much bigger than the bumper crop reported by the government. Those imports drove down domestic prices to the point where rural revenue was suffering, so China simply started buying more corn from farmers to prop up prices, supporting the farmers while continuing to import large amounts of corn from Brazil and Ukraine, as well as grain sorghum from the United States. Again, this may simply be China trying to restore what was once large reserves of essential commodities, or it may be preparing for something. What we do know is that imports of many basic commodities have exceeded domestic demand over the past year.
The 5-Year Breakeven Inflation Rate reflects what the market expects inflation to average over the coming five years. It has correlated well over the past 10 years with money flow in and out of the broader commodity sector. In fact, the 10-year correlation between it and our StoneX Commodity Tracker – broad basket of commodities – is a strong 0.87. Its 10-year correlation with our StoneX Grain and Oilseed Sub-Tracker is a solid 0.84. Money tended to come into the commodity sector with managed money building long positions in times when inflation expectations were rising, while they tended to short the commodities when they felt that inflation was trending lower, as has been the case since June 2022. That doesn’t mean that every commodity is treated that way. Fundamentals still matter, but it does tend to impact the value level at which the market manages supply and demand. The 5-year Breakeven Inflation Rate has leveled off after being in a period of decline since 2022, with signs that it may be turning higher. Historically, the change in money flow tended to lag changes in inflation expectations by two to three months. In fact, history may not repeat itself this time. However, one has to wonder whether fund managers will want to maintain large short positions in the commodities if they see inflation pressures start to rise once again? In the past, they’ve preferred to own commodities during times of rising inflation to protect the value of their portfolios. This is something that I’m watching as reinflation risks rise again in the months ahead.
