What the Fed hike means for commodities
Head of Commodity Strategy
Summary: Gold, crude oil and copper put in different responses to last night's US rate hike, but given the Fed's unexpectedly hawkish tone, what's the outlook like for these three bellwether commodities in the months ahead?
The Federal Open Market Committee and Chairman Powell stood their ground yesterday as they unanimously decided to hike the Fed funds rate by another 0.25% to 2.5%. While the rate hike was dovish given the lowering of their forecast for hikes next year, the market had clearly been looking for a stronger dovish shift. The subsequent press conference turned out to be far less dovish than anticipated as Powell touted the strength of the US economy, robustly defending the Fed’s independence when asked about Trump’s tweets. He even went out of the way to praise the Fed’s Quantitative Tightening (QT) schedule.
Judging from the reaction in stocks and not least US Treasuries, the market seems to be telling us that the Fed is making a policy mistake that it will eventually be forced to reverse. The yield on US 10-year notes dropped to 2.75%, the lowest since April, while the 2-10-year spread flattened further to reach 10 basis points.
While the FOMC was busy looking at incoming data, the market has been looking forward and is clearly seeing much bigger clouds on the horizon. Commodities reacted differently with growth dependent commodities such as crude oil and industrial metals falling while safe-haven assets such as gold remained firm despite some initial dollar-related weakness.
Gold, which reached a five-month high ahead of the announcement, ran into some initial profit taking as it reacted to the initial dollar strength following the rate hike. But the subsequent sell-off in stocks and drop in bond yields soon attracted renewed buying interest and given the troubled economic outlook into 2019 we see the upside potentially for gold as strengthened further by the Fed’s decision.
However, the best cure for a low price is a low price and once again we are likely to see this mechanism kick in as supply may suffer, not least in the very price sensitive US shale oil market. But just like the during the sell-off between 2014 and 2016 the full impact on US shale oil producers' ability to grow their business due to falling prices may not be visible for several months. In the short term the market will worry more about the global growth outlook, especially in emerging markets where a smaller (dollar) credit cake and the rising cost of funding will continue to create uncertainty about demand despite the potential boost from lower prices.