Perspective: Morning Commentary for September 19

By: Arlan Suderman, Chief Commodities Economist

Mon, 19 Sep 2022, 13:25

Perspective: Morning Commentary

Arlan Suderman

Chief Commodities Economist

September 19 – Leaders from around the world are gathered in London today to mourn the loss of Queen Elizabeth. Some markets are closed to watch the state funeral. Meanwhile, U.S. stock futures were under pressure this morning as Wall Street braces for Fed week, fearing that the central bank’s current dose of medicine for curing inflation will do significant harm to the economy. The VIX is near 28 this morning, reflecting elevated fear levels on Wall Street. The dollar index is firmer as well, trading near 110.0 in early trade to start the week. Yields on 10-year Treasuries are trading near 3.51% earlier this morning, representing a fresh 20-year high, while yields on 2-year Treasuries are trading near 3.94%, which is a fresh 14-year high. Crude oil prices are more than 3% lower as the above fears raise fresh demand concerns, while the grain and oilseed sector is under pressure this morning as well, with the broader markets in a modest “risk-off” mode to start the week.

The Federal Open Market Committee of the Federal Reserve will meet to discuss possible changes to monetary policy on Tuesday and Wednesday of this week, releasing its updated policy statement at 2 p.m. EDT on Wednesday, followed by a press conference with Fed Chair Jerome Powell 30 minutes later. Fed Fund futures trading suggests that the market gives 80% odds that the Fed will raise its benchmark interest rate 75 basis points on Wednesday to 3.0%, with a similar hike likely in November. The Fed is raising interest rates while simultaneously reducing its balance sheet – withdrawing stimulus from the economy – to slow consumer demand while also seeking to reduce wage inflation by increasing the unemployment rate to historical norms. That means inflicting some pain on the economy. Wall Street fears that the pain will be more than the economy can bear. As such, the commodity sector is trading recession fears more than it is supply and demand fundamentals, leaving the cash market to do the job of managing supply and demand for the time being.

President Biden angered China Sunday evening when he stated in a national TV interview that U.S. military forces would help defend Taiwan in the event of a Chinese invasion. The reporter then sought for clarification, asking again if that meant that the United States would utilize American men and women serving in the military to help defend Taiwan, to which he replied, “Yes.” This is a sharp change from the long-standing stated policy the United States has had on Taiwan, with this statement being much clearer than previous statements he has made that seemed to follow a similar line. A White House spokesperson later again said that U.S. policy towards Taiwan had not changed, but China heard otherwise. It released a statement lodging a formal complaint and warning that China reserves the right to take all necessary measures to counter separatism. Chinese President Xi Jinping has vowed to “reunite” Taiwan to the Mainland, and he seems resolute to do so. President Biden’s comments come as a bill slowly moves through committee in Congress seeking to increase military support for Taiwan’s independence.

The overnight commodity market is indicative of what we’ve been seeing a lot of lately. Fund managers paint with a broad brush, reflective of their fears that high inflation and high interest rates are rapidly taking us into the type of recession that will reduce demand for raw commodities. That’s certainly truer for some commodities than for others, but traders are treating them all pretty similarly. The momentum-trading Algos feed on this, amplifying the move. The market will always eventually do its job of managing supply and demand, but there are times when the cash market does the work while the futures market focuses on other issues. The corn market is a good example of that currently, although there are aspects of that seen in other commodities as well. This may prove to be the norm for a while, depending on how long fund managers remain focused on the recession mantra. Something needs to happen to refocus them on tight supply and demand fundamentals if we expect to see a change in the money flow. Until then, the cash market will do the work, with strong basis trying to balance supply and demand.

Will fund managers focus on inflation once again, using the commodities as a hedge against inflation? Possibly, yes. I see the real key indicator longer-term as being Europe’s ability to weather the winter with energy supplies and prices. Supplies of energy will be tight, with prices high. But those high prices are an essential part of the rationing process. Leaders are moving towards capping prices, which doesn’t allow the market to ration demand, frequently leading to shortages, and even higher prices. That could dramatically impact diesel fuel, fertilizer, and other crop input prices in the Northern Hemisphere for next year – adversely impacting production. Will that happen? Again, it depends on how Europe weathers the winter months amid the ongoing Ukraine war.

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