Commodities diverge as uncertainty spreads

The most important FOMC decision of this cycle

Stepping into this global mess of uncertainty is the FOMC, which on Wednesday is going to deliver the most important decision during the current rate hike cycle that began back in December 2015. As Saxo FX Head John Hardy wrote in his FX update today, the market is begging for FOMC mercy. Will the Federal Reserve prove willing to pull a dove or two out of its hat, or is Powell determined to hit neutral?

Over 40 basis points of rate hike expectations have been priced out or the December 2019 Fed Funds future since early November and the question Wednesday is now whether Powell delivers a dovish hike (followed by a pause) or no hike at all. 

The 30-day Fed Funds forward curve has collapsed since early November with the peak in rates already seen next year. 

Crude oil

The sell-off in crude oil has resumed after initially pausing in the aftermath of the Opec+ decision to cut production by 1.2 million barrels/day over the coming months. The limited bounce seen in the aftermath of that decision combined with the continued deterioration in the macro outlook has acted as a red flag, not to the bulls, but instead the bears who have sent WTI and Brent below the psychological important levels at $50 and $60/barrel respectively.

Apart from the stock market sell-off, the latest weakness was driven by the EIA which in its monthly Drilling Productivity Report for January saw US shale oil production rise by 134,000 barrels/day to 8.17m b/d. 

Following the renewed weakness below $60/b, Brent crude oil is close to challenging support at $57/b, the 50% retracement of the rally from the 2016 low. A break below would from a technical perspective put $50/b into focus. 

Gold

Precious metals, meanwhile, have rekindled their role as a safe haven amid all the uncertainty hitting other markets. This has been most noticeable after hedge funds last week collectively surrendered the bearish beliefs they have held the previous five months. Spot gold is currently testing the recent high while being within striking distance of the 200-day moving average at $1,253.5/oz. We maintain a positive outlook for gold and not least silver, given its historical cheapness to gold, into 2019 with a dovish FOMC and later a weaker dollar providing the support the markets need in order to move higher. 

Gold has been in an uptrend since August but only last week did hedge funds revert to a net-long position. Additional gains are therefore likely to attract continued buying from funds as they rebuild long positions. In the short-term the market will be focusing on resistance at $1,253/oz, the 200-day moving average followed by $1,263/oz as per the chart below. Only a break above $1,287/oz will from a technical perspective confirm that this current move is more than just a correction within the downtrend that began back in April. 

HG copper

Most industrial metals, and copper in particular, are trading lower today after Chinese president Xi Jinping's keynote speech offered no fresh initiatives to stimulate the country’s economy. The speech was held to mark the 40th anniversary of the Reform and Opening Up campaign that helped trigger the country’s economic boom. HG copper dropped to a one-month low but has so far managed to stay within the sideways trading formation seen since July.

With the combination of the ongoing trade war between the US and China and recent weakness in key economic data such as retail sales and industrial production, the market has been looking for action from the world’s biggest consumer of industrial metals. 

While headline risks to copper remain elevated, the fundamental outlook has been providing some support on expectations that the market will tighten into 2019. We favour the upside on the back of increased risk of additional Chinese stimulus measures raising demand at a time where global mine production looks set to contract. The key risk events for industrial metals, apart from Wednesday’s FOMC meeting, will be China’s annual Central Economic Work Conference which kicks off Wednesday and which will run into Friday.

This is the forum where detailed plans for the year ahead are revealed and given the current outlook some additional measures to stimulate the economy may see the light of day.