Perspective: Morning Commentary for January 10

January 10 – Stock gains are muted ahead of key inflation data to be released over the next two days. The VIX is trading just below 13 this morning, while the dollar index is trading near 102.5. Yields on 10-year Treasuries are trading near 3.99%, while yields on 2-year Treasuries are trading near 4.33%. Crude oil prices are 1% higher, supported by increased risks for shippers in the Middle East, while the grain and oilseed sector was mostly weaker overnight. The latter is now focused on USDA’s annual January data dump scheduled for Friday, that is known for its surprises due to the sheer volume of data contained within it.

The broader commodity sector was mixed overnight, with crude oil pushing higher, and the grain and oilseed sector weaker. Crude oil prices are chopping sideways, with WTI crude oil spending much of the past month between $70 and $75 per barrel. The choppy sideways nature of the crude oil market reflects a market struggling to balance conflicting fundamentals. Support comes from geopolitical risks in the Middle East that continue to slowly increase. The market is concerned about risks that the conflict could spread to the point of negatively impacting crude oil output from the region. Yes, attacks on tankers in the Red Sea increase the cost of freight as shippers divert to longer routes, but they don’t ultimately change the overall supply. They lengthen shipping routes, which ties up tankers longer for each delivery, while adding cost, but they don’t change supply in the long-term. The true risks to supply come if attacks are made on production and shipping infrastructure.

But price gains are limited due to current soft demand, tied to an anemic domestic and global economy, with particular focus on China. The good news is that the recent announcement from Saudi Arabia that it would slash its price for its Asian customers to 27-month lows appears to have triggered fresh demand. The bad news is that the fresh demand increased shipping costs of U.S. crude to the Asian market from roughly $8 million for one of those super tankers last week to closer to $10 million now. That erased the arbitrage advantage that U.S. Gulf crude enjoyed, so we shifted the supply from the United States to Saudi Arabia. Furthermore, gains are limited by a growing uneasiness about whether Saudi Arabia will be able to hold the power of the OPEC cartel together. Angola recently left OPEC, frustrated over the production limits assigned to it. The economies of oil-producing countries are largely dependent on oil revenue. They’re limiting output, but that’s not getting them the revenue needed with prices generally not responding due to soft demand and increased output in non-member countries. Angola provided just 4% of OPEC’s output, but it reflects possible cracks in the cartel. OPEC held 35% of the global market share not that many years ago, but that share is now down to 21%, and its share continues to decline. At what point does the cartel fall apart and its members pump as much as possible to bring their revenues back up by focusing on volume?

Meanwhile the grain and oilseed complex has been trading mostly sideways to lower, continuing the broader theme of managed money that we are in a commodity deflation mode. Prices of a particular commodity may rally when a supportive headline emerges, such as an attack on a tanker in the Red Sea, or a wheat cargo hitting a mine in the Black Sea, but then prices resume their commodity deflation mode once that headline goes quiet again. We’ve been in this broader commodity deflation mode for much of the past year and a half. Managed money built short positions within most commodities over that period of time, with a few exceptions for those commodities that had a story. The underlying sentiment made it more difficult to sustain rallies, with the broader trend being lower because managed money expected lower inflation in the future than what it saw currently, and it worried about an approaching recession further eroding demand.

That recession never happened, and it may not. Wall Street is divided over what happens next. I’m in the camp that perceptions of a Federal Reserve pivot, combined with lower gas prices and interest rates boost consumer demand, increasing demand for housing and goods and services, elevating inflation again as we move deeper into 2024. That’s not saying that we necessarily return to the previous highs, but I see elevated inflation pressures again. But the Fed will struggle to deal with that inflation, because a rapidly rising supply of debt certificates due to fiscal spending will pressure it to pull back on its quantitative tightening, giving up on the 2% mandate. Managed money no longer perceives declining inflation under this scenario, leading it to abandon the commodity deflation position, even building ownership in select commodities. That doesn’t mean that I’m bullish the commodities, but such a scenario would increase end user risks, while providing increased opportunities for producers, if it unfolds.