July 19 – A cautious optimism continues to create supportive tailwinds for stocks this morning, while headlines are increasingly focusing on strength in the commodity sector as well. The two go hand-in-hand, as Wall Street focuses less on recession risks, and more on those factors that could create stronger demand and/or supply threats, with the Russian/Ukraine war again a factor that increases inflation risks. This morning’s housing starts data was disappointing, but it wasn’t a game-changer in shifting sentiment. The VIX is trading near 13 in early trade this morning, while the dollar index is trading near 100.2. Yields on 10-year Treasuries are trading near 3.76%, while yields on 2-year Treasuries are trading near 4.72%. Crude oil prices are modestly higher this morning as they consolidate just below the 200-day moving average. But the energy of the commodity sector is in the grain and oilseed sector this week as tensions rapidly escalate in the Ukraine war.
Russia launched a second major missile attack on grain and oil facilities at ports near Odessa overnight, supplemented with drone attacks as well. The significance of last night’s attack was not missed by the markets, but we must look at it within the context of other events this week. First, Russia formally withdrew from the Black Sea Grain Initiative on Monday, following an apparent Ukrainian attack on the Kerch bridge that connects Crimea to Russia, and which provides a critical supply link for Russia to support its war efforts in southern Russia. The two may or may not be related, but together they represent an escalation of the war effort. The markets said on Monday that it didn’t care about the collapse of the BSGI because a) Russia is dumping a lot of cheap wheat on the world market currently, b) Brazil is dumping a lot of cheap corn on the market currently, and c) Ukraine announced that it would implement Plan B to maintain the initiative without Russia’s support. The market was right on Monday for the here and now, but that doesn’t change the fact that Ukrainian production and exports do matter to world supplies longer-term. Ukraine can continue to move up to 2 million metric tons of exports through other channels, but it will be difficult to move the additional four to five mmt per month that it had been moving through these ports.
The question was, would Russia allow the BSGI to go on without it? To do so would be to let go of a major bargaining chip, while appearing weak. Russia could not allow that to happen. The focus has been on whether Russia would strike a ship to make shippers wary of entering the ports, but Russia was more likely to strike the ports, which is what it’s done. Striking the ports is the less damaging of the two options in the world of public opinion, and it accomplishes the same objective. The move is certainly expected to escalate tensions with Ukraine, which now has more long-range weapons to use in retaliation, compliments of NATO. So why did corn prices lead the way higher on Tuesday as the market began to comprehend the above, when corn has the weakest fundamentals? That’s where the bulk of the short positions were that grew quite nervous as the above events began to unfold. The shorts ran for the doors, and the momentum-trading Algos jumped into the party as well. Chicago wheat also had plenty of nervous shorts, while soybeans have their own supportive fundamentals to trade in a tight balance sheet threatened by a warmer drier Midwest forecast as we go into late July. Suddenly, you have a developing story that’s capturing the focus of fund managers who are less focused on recession worries.
The two-week outlook for the Midwest fits into the above story quite well. The weather pattern is expected to warm up and dry out across the Midwest next week, into the early days of August, as the corn and soybean crops go through critical development stages. Our forecasters think there will continue to be more ridge-running storms in the Midwest than shown in the models, but it will still lean dry. Beyond that is the question, with some forecasters calling for a hot and dry August, while others are calling for a mild and wet Midwest in August, with far different implications for the crops.
Meanwhile, China’s economic struggles continue. It knows that it must stimulate domestic demand to offset lost export business as Europe and the United States decouple. It finally figured out that regulation is stifling growth in its tech sector, which is another critical component of its economy. As such, it’s lightening up on regulations that are hoped to strengthen its private tech economy, which when you include all the various support sectors, could support domestic consumption. That’s because the online service operators from social media and video gaming to e-commerce and food delivery, generate more than 240 million jobs, including truck drivers, ride-hailing drivers, and delivery riders. This group of workers accounted for more than 25% of the working-age population. Less regulation creates jobs that stimulate consumption. On the other hand, China countered those steps by prioritizing support for State Owned Enterprises, using national security to justify the move. It indicated that it wants the SOE’s to lead China forward, which puts it in direct conflict with needing support from the critical foreign investment needed from investors in the West, while increasing the distrust that the West has in China’s economy and in its intentions.
