Head of Commodity Strategy
Summary: Commodities started March on a firmer footing after data from China confirmed that activity in the world’s biggest consumer of raw materials is picking up momentum. Gains however were held back by the prospect of sticky inflation elsewhere leading to higher rates and lower growth, and given these opposite pulls, the short-term outlook remains balanced with no clear driver yet emerging to significantly change the stalemate between bulls and bears. This is most visible in the energy market, where crude oil has traded rangebound since late November.
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Today's Market Quick Take from the Saxo Strategy Team
Commodities started March on a firmer footing after data from China confirmed that activity in the world’s biggest consumer of raw materials is picking up momentum. Gains however were held back by the prospect of sticky inflation elsewhere leading to higher rates and lower growth. This comes after euro-area inflation rose 8.5% on an annual basis in February, unchanged from January, and contrary to expectations for a drop, while underlying price pressures surged to a new record high at 5.6%. In the US, 10-year Treasury bonds topped 4% for the first time since November in response to data pointing to continued price pressures. This supports the view that the US Federal Reserve will continue to raise rates and then hold them for as long it takes to get inflation under control.
The swaps market is now pricing in a peak in US rates around 5.6% by September, with the futures market looking for a near one percent cut in the following twelve months. In other words, incoming economic data will need to remain strong in order to support the more than 75-basis point rate hike currently priced in. Any weakness would inadvertently lower expectations while shortening the duration of peak rates. This heightens growth concerns while also supporting risk appetite through an accompanying weakness in the dollar and softer bond yields.
Following a February lull in the expectations for a post-Covid economic rebound in China, that focus returned to the fore after the February Manufacturing Purchasing Managers Index (PMI) surged to its highest level since 2012. Another report showed China’s home sales rising for the first time in 20 months, after policy makers stepped up their support for a struggling sector. The strength of the current economic recovery has, according to a report, surprised China’s leaders, suggesting the government will be restrained in rolling out new stimulus measures this year.
With that in mind, the focus now turns to the Chinese government and what they will do to further support an economic recovery. The first session of the 14th National Committee of the Chinese People's Political Consultative Conference (CPPCC) will begin on March 4, followed by the 14th National People’s Congress (NPC) the next day. During what is collectively known as the “Two Sessions”, Chinese officials will release a set of social and economic development goals as well as their official growth forecast and various policy measures to achieve them.
The commodity sector spent most of February on the backfoot with losses seen across key commodities, from energy to industrials and precious metals. These losses were primarily driven by continued strength in US economic numbers, including inflation, forcing the Fed to turn up the hawkish rhetoric while at the same time sending bond yields and the dollar higher—thereby hurting risk sentiment across the stock and commodity markets. However, while some of these worries have been offset by the mentioned strength in Chinese data, the short-term outlook remains balanced with no clear driver yet emerging to significantly change the stalemate between bulls and bears. This is most visible in the energy market, where crude oil has traded rangebound since late November.
The Bloomberg Commodity index—which tracks a basket of 24 major commodity futures spread almost evenly across energy, metals and agriculture—trades down 4.2% on the year after a 4.7% decline last month wiped out January’s gains, especially among precious and industrial metals. Gains have primarily been concentrated among the soft commodities of coffee, sugar and cotton, all of which are supported by a tightening supply outlook. The energy sector scrapes the bottom, primarily because of losses in an oversupplied US natural gas market. As in Europe, the price of US natural gas slumped last month as the mild winter reduced demand for heating, before suddenly posting a near 30% gain this past week on signs production may begin to suffer from falling prices and a pickup in LNG exports to a one-year high.
In crude oil, we are increasingly likely to see a year of two distinctive halves. The first half will comprise a market that remains rangebound, with global growth worries offsetting robust and rising demand from China and India. Later in the year, we see an overriding risk of the market beginning to tighten as a recession in Europe and the US fails to materialize thereby supporting a swing from market surplus to deficit. In addition to this, the prolonged war in Ukraine is creating difficulties for Russia to maintain its current level of production, primarily due to difficulties in rerouting its oil products away from Europe. What’s more, there is increased competition from refiners in the Middle East, an emerging refinery hub that will see capacity grow even further during the second half.
Crude oil, rangebound since November, continues to lack the directional input that may see it break out of established ranges, for Brent between $80 and $89, and for WTI between $73 and $83. The strength of China’s economic data helped offset continued concerns regarding the economic outlook in the US and Europe—where interest rates look set to rise further in the coming months. These developments, together with a softer dollar and prompt spreads indicating a tightening market, supported a small weekly gain. In Brent, a weekly close above its 21-DMA at $83.75 may signal some additional upside momentum, but overall, we do not see a breakout of the mentioned ranges anytime soon.The ICE Futures Europe exchange released four weeks' worth of delayed Commitment of Traders (COT) data on Friday, February 24, with reporting now up to date following the January cyber-attack on ION Trading UK, which caused delays in trades being reported. The US CFTC meanwhile released one COT report for the week ending January 31 with data unlikely to be up to date for another three weeks. ICE Brent data showed unwavering support for higher prices with the managed money or hedge funds catagory holding a net long of 277k lots, a 16-month high and the weakest gross short position at 28k since 2011.
Gold was heading for its best week since mid-January following a hot EU inflation print and strong economic data from China, a top buyer of gold. This resulted in a softer dollar and gold moving higher to challenge the 21-DMA, currently at $1844 for the first time since February 3. Earlier in the week, Federal Reserve Bank of Atlanta President Raphael Bostic said that US Fed funds rates could rise to 5.25% and stay there well into 2024, but with the market already pricing a terminal rate above 5.5%, the impact of his comment had a limited negative price impact.
It is also worth noting that this week's 10 basis point jump in US 10-year bond yields has primarily been driven by rising breakeven rates (inflation) leaving real yields close to unchanged. This supports our long-held view that sticky inflation will over time force a repricing higher of future inflation expectations. Together with underlying demand from central banks, the upside potential for gold has not been damaged by the recent correction. However, for the current recovery to attract support from technical buyers, prices of gold and silver as a minimum need to break $1864 and $22 respectively to signal an end to the current corrections.
Copper, aluminium, zinc and iron ore all traded higher following the mentioned batch of economic data from China showed improved factory activity as well as rising home sales, both driving expectations for an accelerated demand recovery. The news added further momentum to an already recovering copper market which recently retraced to and found support in a key area just below $4.
However, following a recent strong rise in exchange monitored inventory levels in New York, London and not least Shanghai to a September 2021 high, the immediate prospect for a strong rebound looks unlikely until this overhang of stocks is being met with rising demand—a process that will likely take months to unfold. Focus now turns to China’s ‘Two Sessions’ and what the government will do to further promote a post-lockdown economic recovery.
Overall, we maintain our long-held bullish view on industrial metals, not least copper. However, with the mentioned overhang of stocks, the timing of the next sustained move higher is unlikely to be triggered until the second quarter or later. The timing is, to a certain extent, dependent on the economic outlook for the rest of the world and whether recession, as we believe, can be avoided. For now, the market will be looking to the price action for clues, not least how traders respond to a retest of $3.95 support or $4.24, the February peak.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
