Perspective: Morning Commentary for August 12

By: Arlan Suderman, Chief Commodities Economist

Fri, 12 Aug 2022, 13:24

Perspective: Morning Commentary

Arlan Suderman

Chief Commodities Economist

August 12 – Stocks have an upbeat tone to them as we prepare to end the week, while the opposite is true for much of the commodity sector this morning. The VIX continues to consolidate either side of 20 this morning, reflecting a general sense of relief on Wall Street heading into the weekend. The dollar index bounced to trade near 105.6 this morning, contributing to weakness in the commodities. Yields on 10-year Treasuries are trading near 2.84% this morning, while yields on 2-year Treasuries are trading near 3.17%. Crude oil prices are more than 1% lower in early trade, while the Ags had a weaker tone as well ahead of today’s USDA WASDE crop report.

Wall Street inflation fears transitioned into recession fears in mid-June, leading to a major shift in money flow away from the food and energy-based commodities. A technical recession was confirmed by gross domestic product contracting in consecutive quarters in data released last month, seeming to result in a sigh of relief by equity traders. That precipitated a significant bounce in stocks, while commodity traders continued to trade recession fears. The macro-market assumption has been that demand for commodities is lower in a recession. That’s true for some commodities, but not for others. But there’s also the debate over whether we are actually in a recession or not? The data is quite conflicted on that. Certainly, some sectors of the economy are in a recession, but the monthly jobs report released on August 5^th is not one that you get during a recession. The job market remains extremely tight, reflecting the continued desire of employers to hire employees who can’t be found. That doesn’t happen in a recession. Yet, we’re now starting to see early signs that the employment sector may be slowing as well.

Gasoline demand dipped below levels seen in the middle of the pandemic lockdown of 2020 last month, according to data released by the Department of Energy. A drop in gasoline consumption is consistent with what you’d expect in a recession, but in this case, it was also caused by a surge in the national average price to record levels near $5 per gallon. But did demand really fall that far? That’s been the subject of considerable debate within the industry in recent weeks, with private and government data seeming to conflict. Much of the difference likely revolves around how the DOE calculates the data, and that should eventually show that the truth is somewhere in the middle, which is what logic would support. Nonetheless, prices broke hard on that data, which has begun to bring back demand. Wall Street talks of “peak inflation” as the data shows a big slowdown in month-on-month price gains largely driven by that late June / July break in commodity prices, but many of the commodities still face significant supply risks over the next several months that could rejuvenate inflation.

A key indicator that I will be monitoring is the supply of, and price for, natural gas in Europe as we head through the fall into winter. European gas prices are much higher than those in the United States because the supply is much tighter. Supplies coming from Russia are reduced at a time when most countries there are seeking to build their inventories for the winter. Their goal in most cases is to fill their reserves to 80% capacity prior to November 1^st. Most countries should be able to meet or exceed that goal. That should be sufficient to get them through the winter with the conservation measures put in place, as long as they have a normal winter season. A colder-than-normal winter could create problems, resulting in shortages. Some industries that depend on natural gas are switching to diesel fuel, which is also tight globally. U.S. distillate stocks are 24% below seasonal levels as we head into the fall harvest, which is a high demand time for the fuel. European fertilizer plants are running at about 60% of normal capacity, sustaining that level due to heavy government subsides as leaders try to avoid food shortages. That would be at risk if natural gas supplies get tighter due to a cold winter. Natural gas is also a feedstock for many other crop inputs produced in Europe and sold around the world. There’s a cautious optimism that we can get through this winter at the status quo, but the margin for error will be quite small, unless the Russia/Ukraine conflict somehow suddenly dissipates. Any major gas shortfalls could lead to a very volatile 2023 in the commodity sector.

Today is USDA WASDE crop report day at 11 a.m. Chicago time. Areas to watch are a) corn and soybean yields, b) changes in acreage following USDA’s resurvey of Minnesota and the Dakotas (I look for lower corn and modestly higher soybean acreage), c) notable cuts in Europe corn production, and d) potential significant adjustments in Russian wheat and/or export estimates. There’s also a chance that we see a surprise in the U.S. spring wheat production estimate after crop ratings tumbled in South Dakota on Monday during the active harvest period. Barring any surprises today, the focus will shift to the industry crop tour scheduled for the week of August 22.

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