Perspective: Morning Commentary for January 22

January 22 – Stock futures reflect Wall Street’s desire to add to Friday’s big gains, as optimism trumps fears over delayed rate cuts by the Federal Reserve, and while China’s stock market continues in meltdown mode as confidence in its economy slowly erodes. The VIX is trading near 13 to start the week, while the dollar index is trading near 103.2. Yields of 10-year Treasuries are trading near 4.09%, after rising to five-week highs on Friday, while yields on 2-year Treasuries are trading near 4.38%. We’re starting the week with crude oil prices modestly higher on escalating geopolitical risks, although prices remain within the $70 - $75 trading range that has largely contained the commodity over the past month. Grain and oilseed prices tried to follow through on Friday’s strength but hopes of doing so began to wane as U.S. trading desks started to open this morning.

China’s central government instructed some heavily indebted local governments to either delay or to halt altogether some infrastructure projects, according to a report by Reuters, which cited sources familiar with the situation. The pattern in China is for the central government to direct projects which are seen as beneficial for the Chinese economy, but those projects are typically funded through local government entities. That puts the debt on those local government entities, which face greater challenges due to the eroding property sector. Chinese consumers keep waiting for the government to stimulate the property sector sufficiently to restore their confidence in the economy, but they have not yet seen anything that would instill that confidence again. This latest move is confusing to analysts, if the report is true, because it suggests that the government is shying away from infrastructure stimulus projects at a time when such are needed, although it may mean that the central government is considering a change in strategy in a more targeted manner, and/or a more centrally managed strategy? Or, could it possibly mean that the debt problem is worse than feared for local government units? Regardless, China’s stock market continued to erode near five-year lows as confidence in government statements about it having everything under control lack belief.

But Wall Street is trying to move past the China news toward optimism over how artificial intelligence (AI) is going to carry us through any headwinds created by China’s problems or the Middle East war. In other words, Wall Street sees the proverbial glass as “half full” rather than “half empty” as we move through earnings season, choosing to take an optimistic attitude, even if the Fed isn’t able to pivot to rate cuts as soon as it would like. I’m hearing less of a gloom and doom picture of recession, with more of a focus on resiliency as stocks move to record highs. The next thing that I’m listening for – and I’m starting to hear it – is the return of inflation talk. Historically, managed money does not like to be short the commodities if it perceives that we’re entering a period of inflation, as can be seen on our StoneX Commodity Tracker in the Interactive Report section of the StoneX portal. There’s a strong correlation between inflation expectations – as measured by the five-year inflation breakeven rate – and money flow into or out of the commodity sector. History tells us that the perception of managed money toward inflation expectations correlates well with whether it wants to be long or short the commodities. History shows that this changes the level at which the market manages supply and demand for those commodities, even with similar supply and demand fundamentals. Managed money has been in a commodity deflation mode since June 2022 based on its expectations that inflation would be trending lower, and that we would go into a recession, which required fewer commodities. Looking at the grain and oilseed sector, managed money currently has near-record short positions in the sector. At what point will a flip in expectations lead them to flip from short to long? My guess has been the second or third quarter of this year, but the vastness of their short positions may trigger it sooner.

There’s nothing bullish about the grain and oilseed fundamentals, as shown by the January 12 USDA set of reports. Fundamentally, something needs to change the narrative. Brazil’s harvest is ahead of the normal pace, but so is the pace of planting the winter corn crop, although we’re still at less than 10% for both. We are seeing some increased demand at these price levels, with end users also worried about what a short-covering rally could do to their costs. That doesn’t mean the bottom is in, but end users are recognizing that their upside risks rise the lower prices go and the shorter the fund positions get. Cheap prices are buying fresh demand for corn and wheat, and to a limited extent soybeans, although it hasn’t flipped the fundamentals bullish by any means. Brazilian beans are still $2 per bushel cheaper than Brazilian soybeans shipped to China for February through April loadings. We still have 2+ billion bushels of surplus corn, and a lot of hard red winter wheat. It’s just that a lot of that has been priced in.