September 6 – Follow-through selling pressured stock futures overnight, as traders fret about sticky inflation in the economy ahead of this afternoon’s release of the Federal Reserve’s Beige Book. The VIX is trading near 14 this morning, while the dollar consolidates near 104.7 after rising to its highest level in nearly six months on Tuesday. Yields on 10-year Treasuries are trading near 4.25%, while yields on 2-year Treasuries are trading near 4.96%. Crude oil prices are modestly higher after trading above $88 per barrel on Tuesday, which was its highest level for a spot contract since mid-November of last year. The grain and oilseed markets were mostly higher overnight after USDA’s weekly crop progress report showed greater deterioration in the corn and soybean crops than expected on Tuesday afternoon.
The Federal Reserve’s Beige Book is published eight times a year two weeks ahead of the next meeting of the Federal Open Market Committee. The Beige Book provides a detailed analysis of the U.S. economy that policymakers study when considering potential changes to monetary policy. This Beige Book is expected to again show a resilient economy with signs of slowing. However, it’s also likely to show that inflation remains sticky in the service minus shelter category that the Fed has been focused on, due in large to sticky wage inflation. We’ve seen signs of easing wage inflation, but the primary debate will be whether it is sufficient to justify a pause, or whether another rate hike is needed? Fed fund futures trading currently only places 7% odds of a September rate hike, so the market is ill-prepared for a hike in two weeks if it were to happen. However, those odds jump to 43% for a November rate hike. As such, the market is prepared for the possibility of another rate hike. It just doesn’t expect it to happen at the September meeting.
Commodity inflation is another emerging concern for the Federal Reserve and for the markets. Crude oil prices surged to fresh 8-1/2-month highs on Tuesday after Saudi Arabia extended voluntary production cuts to December, to go along with Russia’s voluntary cuts announced in the past week. The cut extensions, which total 1.8 million barrels per day, come at a time when some analysts are questioning whether China’s demand is as soft as first thought? It must be noted that the above cuts are partially offset by an increase of 200K bpd coming from Iran, which is not subject to OPECs quota cuts, in addition to small increases from Nigeria. The price trend over the past 60 days reflects concerns that global demand is out-pacing supply, drawing down supplies. That tightness extends to the products, with global diesel supplies now in the 24th percentiles for levels typically seen in early September. The correlation between the U.S. consumer price index and our StoneX commodity index over the past 10 years is a very strong 0.90, with energy being 44% of that index. Rising energy prices have a significant impact on inflation expectations, with the Cleveland Fed inflation nowcaster now forecasting the headline consumer price index to rise by nearly 0.8% month-on-month. The next question then will be whether we see enough of a drop in U.S. crop ratings following this year’s adverse weather to see strength in grain prices to go along with the strength already seen in beef prices to add to food inflation?
Corn condition ratings took a hit over the past week, but soybean ratings really grabbed the market’s attention when its condition index score dropped by 10 points on Monday afternoon. My corn yield model fell a bushel to 173 bushels per acre with this week’s condition score loss, while the soybean yield fell nearly ¾-bushel to 50.2 bpa. That would be fine, except this is the type of growing season in which yield models tend to over-state yields, just like this year’s satellite based NDVI scores are likely over-stating yields. This is the type of growing season in which smaller seed size tends to drag down yields to levels below what is expected by the models, and sometimes that decline can be significant. We should start to see that show in USDA’s field sampling for next week’s crop report, if it is the case, but ultimately it will take the combine to tell the full story. This doesn’t change the weak export demand story for corn and for soybeans, or the weak feed demand story for corn. But we also can’t dismiss the possibility that yields will fall sufficiently to offset that weakness, especially for soybeans. The focus near-term will be on the supply side of the balance sheet, likely until the market has a better handle on the size of this year’s crops. The demand side of the balance sheet will be the focus after the trade has a handle on the crop size. Expect USDA to start ratcheting down its demand estimates as it cuts yields, but yield cuts would be expected to exceed demand cuts in the near-term, possibly leading some fund managers needing to cover some short positions.
