Perspective: Morning Commentary for March 27

Perspective: Morning Commentary
Arlan Suderman
Chief Commodities Economist


March 27 – Stock futures quietly firmed overnight, reflecting a hint of cautious optimism ahead of Friday’s PCE inflation data, which is scheduled for release when the markets are closed. The markets will be closed for the Good Friday Easter holiday on Friday, meaning that they’ll need to wait until Monday’s session to factor in any surprises in the data. The VIX is trading near 13 again this morning, while the dollar index firmed to trade near 104.4. Yields on 10-year Treasuries are trading near 4.22%, while yields on 2-year Treasuries are trading near 4.59%. The commodity sector came under modest pressure overnight, although crude oil prices are near session highs at this hour. Grain and oilseed prices are taking a bigger hit ahead of tomorrow’s USDA reports, with managed money defending its big short positions in overnight trade amid weaker chart signals. There’s also an under current of thinking in the market that the closure of the Port of Baltimore is negative for the commodity sector. The closure is a big deal, and its impact on some commodities is notable, such as fertilizer, coffee and sugar, but its impact on the sector as a whole is minimal. Supplies will find alternate routes, albeit at a higher cost for impacted commodities.


The U.S. debt clock currently sits at $34.6 trillion. That wasn’t a big deal when interest rates were near zero. That’s not the case anymore. As a result, we’ve seen the annual interest costs on that debt rise from $350 billion earlier last year to closer to $792 billion today. To put that into perspective, the current annual interest costs for our national debt our approaching what we spend on defense and war each year, and it’s more than half of what we pay out in Social Security benefits each year, which now sits at $1.42 trillion. And that number continues to climb as debt certificates mature and are rolled at today’s higher interest rates, which is the case for more than $8 trillion of our debt this year. No wonder politicians pressed Federal Reserve Chair Jerome Powell to lower interest rates when he testified before two Congressional committees earlier this month. The annual interest obligation will be $2.7 trillion four years from today if we continue on the path that we are currently on, according to I don’t know if we’ll stay on the same path that we’re on, but I don’t see much momentum on Washington to change the course.


So, what does this have to do with the commodity markets? Plenty. First, the interest obligation will increasingly be squeezing the U.S. fiscal budget. I expect that to become a bigger issue after the elections, when a lame-duck Congress, and possibly a lame-duck president, must find a solution to the debt ceiling problem before January 1 when the current suspension of the agreement expires. Perhaps the biggest risk from that showdown will be the possibility of a credit downgrade for U.S. debt – something the credit rating agencies have previously warned us could also result in a credit downgrade. Other options include massive tax hikes, drastic spending cuts, or monetizing the debt by restarting quantitative easing (printing money to buy our debt certificates) to contain the upward movement of interest rates needed to create demand for the increased supply of certificates. We’re likely looking at some combination. The composition of that combination could either send us into a recession, or it could fuel another significant inflationary cycle in a juiced economy. The former would be expected to be bearish the commodities, while history tells us that the funds love to be long the commodities in times of the latter.


But Wall Street isn’t talking about the above approaching risks today. It’s focused on expectations that the Fed will soon be cutting its benchmark short-term rate – the only one it controls – at the June meeting, with three cuts this year and three or four more next year. That’s because it’s finally on the same page as the Federal Reserve. But is that reality? The Fed listed all the reasons that the economy is solid in its remarks earlier this month, giving that as reason to justify rate cuts. It was the same list of factors it mentioned in December as to why it could not yet cut rates. That December meeting was seen as the Fed’s pivot. It didn’t cut rates or alter its plan for reducing the balance sheet at that meeting, but it said that it was ready to start talking about it, which was seen as quantitative easing – just talking about it. It may take 12 to 18 months for rate hikes to have their effect on the economy, but it only takes talking about rate cuts to have the opposite effect. It brought inflation down to roughly 3%, parallel to a decline in commodity prices, but inflation is stuck near that 3% level; still above the 2% mandate. The past three months saw hotter-than-expected inflation, and now energy prices are trending higher, along with home prices. Surplus cash in the system in a couple of months from drying up at best, and the supply of debt certificates is rising by an estimated 23% across the yield curve at a time when demand for them is down. Ironically, yesterday’s consumer confidence report indicated that more than half of the consumers surveyed expect interest rates to rise in the coming year. The disconnect between the consumer and Wall Street is most interesting.

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