February 23 – Stock futures were more subdued overnight as traders prepare to head into the weekend – supported by the great earnings report from Nvidia, but capped by fears that interest rates will stay “high” for longer, combined with ongoing geopolitical risks. The VIX is trading near 14 this morning, while the dollar index is trading near 103.8. Yields on 10-year Treasuries are trading near 4.32%, while yields on 2-year Treasuries are trading near 4.71%. Crude oil prices are more than 1% lower on soft demand concerns, although prices remain in a longer-term up-trending channel. The grain and oilseed markets were mixed overnight, after the lead corn and soybean contracts posted fresh three-year lows.
One reason for the dominance of the United States in the world is that it possesses the dominant global currency – at least that is the view of the Chinese government. As such, reaching its goal of being the world’s strongest economy and military means that it must displace the dollar as the dominant currency. It knows that such won’t take place overnight, but it’s willing to play the long game. Part of its current strategy is to set up alliances via the BRICS nations, and via the Belt and Road Initiative that encourage use of the yuan in trading relationships. It has already utilized the BRICS coalition to set up an alternative bank transfer facility to the SWIFT facility that uses the yuan instead of the dollar as its base currency. Use of the yuan jumped to 4.51% of global payments in January, up from 4.14% the previous month, and more than double the roughly 2% seen a year earlier. China wants the yuan to be seen as a strong alternative on the global market, which means that it needs to protect its value. That is one of the factors limiting its use of stimulus for its economy, for doing too much stimulus now when the U.S. Federal Reserve is in a tightening mode would be expected to further weaken the yuan. China hopes that the Fed will begin cutting rates soon, so that it will have more room for stimulating its own economy.
Crude oil prices remain on an upward trajectory on the charts since their low in mid-December, but they took a softer tone this week as worries that the Federal Reserve will leave interest rates high for longer overshadowed slowly escalating geopolitical risks, primarily in the Middle East. We were spoiled by interest rates near zero for too long, and we began to think that was the norm. In reality, today’s “high” Treasury yields are below the long-term averages that are closer to 6% for 10-year Treasuries. Yet, we think of them as high. Perception is reality in the economy, and in the markets. Consumers who perceive interest rates as high will be slower to spend money on big ticket items, reducing consumption, which slows the economy. Treasury yields topped 15% more than four decades ago, so they were considered “low” when they fell by 30 or 40%, even though that still left them well above today’s “high” rates.
The geopolitical risks matter for crude oil prices, but they’re not currently restricting supplies in the world – only elevating the risks of such. Freight costs are rising due to the risks in the Red Sea, along with transit times, but the supply remains the same thus far. The increased freight costs contribute to higher prices at the pump, but they’re not the primary driver of prices. That allows the market to focus on perceptions that today’s “high” interest rates will result in slower demand. Ironically, the Fed only controls the short-term rate. One of the reasons that we’re seeing yields on 10-year Treasuries push higher is due to the increased supply of Treasuries offered to the market due to high Congressional spending, which is stimulating the economy in this election year. It makes one wonder what will happen come November when Congress and the President are faced with negotiating a new debt ceiling, which is currently suspended until January 1, 2025? Perhaps, the lame-duck Congress – and potentially lame-duck president – will simply suspend the debt ceiling for another few years, and keep spending, adding to the supply of Treasuries offered to the market. At that point, the Federal Reserve might need to return to quantitative easing – creating money to buy those debt certificates or monetizing the debt – to keep a lid on interest rates.
The same dynamics are at work in the grain and oilseed sector as well, except the geopolitical risks are currently lower for that sector. As such, we saw corn and soybean prices both hit fresh three-year lows yesterday. At some point, one has to wonder when prices will be deemed too low to risk not taking advantage of them by end users, with funds taking profits on their near record large short positions. Is that today, next week, next month, next year? That’s the big question. Cheap prices do create demand, and they are doing so. But they have not yet done enough to force the funds to flip their positions. So, until then, the trend continues.
