The Bloomberg Commodity Index (BCOM) traded higher for a third week as it continued to recover from an early January selloff that was driven by the IMF’s global recession warning. Gains were broad, although the energy sector was being weighed down by continued weakness in natural gas as prices slumped to their lowest since June 2021. The themes underpinning prices remain the same, with financial markets seeing a softer dollar and lower yields in anticipation of the US Federal Reserve moving closer to pausing an aggressive rate hike cycle. Since starting last March, this has driven the US Fed Funds rate up to 4.5% with the market now pricing in less than two 25 basis point rate hikes before the pause.
The demand side, apart from the risk of a slowing global economy, is being supported by the prospect of China’s reopening – driving expectations for a pick-up in demand for commodities from the world’s biggest consumer of raw materials. However, with the prolonged shutdown of markets in China during the Lunar New Year holiday, some recent strong gainers, such as copper, iron ore and crude oil paused, thereby allowing other commodities to appear at the top of this week’s leaderboard. In the coming weeks, the risk to supplies of Russian fuel products may add an extra layer of support for gasoline and not least diesel, thereby providing enough support to keep crude oil shielded from recession-related demand fears.
The BCOM agriculture sector index was heading for its highest weekly close in nearly three months and, following a troubled start to the year, both the grains and soft sectors showed signs of bottoming out, as improved fundamentals helped reign in some elevated short positions held by hedge funds – especially in wheat and coffee.
Crude oil trades near unchanged on the month and while recession risks remain and, in some places, have strengthened, the market has managed to find support from an expected increase in Chinese demand and supply concerns related to the February 5 introduction of an EU embargo on Russian seaborne sales of fuel products.
Once the EU embargo on Russian seaborne fuel exports kicks in, we are likely to see prices for gasoline and especially diesel remain supported by tightening supply – not least if the embargo is being followed up by a $100 per barrel price cap on diesel, a level that is some $30 below current market price. Russia may, however, struggle to offload its diesel to other buyers, with key customers in Asia being more interested in feeding their refineries with heavily discounted Russian crude, which can then be turned into fuel products selling at the prevailing global market price.
Supply of diesel to Europe from the US and the emerging refinery hub in the Middle East may make up some of the missing barrels from Russia, but a shortfall seems likely, not least considering the prospect for a strong recovery in China leading to lower export quotas. In addition, the recovery in jet fuel demand will pressure diesel yields, thereby creating another layer of support for distillate cracks on either side of the Atlantic.
Brent is currently trading within a $9-wide up-trending channel within a medium-term downtrend, both offering firm resistance in the $89-$90 area. A breakthrough is likely to send the market higher towards the 200-day moving average, currently at $97.50. Ahead of channel support at $80.35, some support is likely to be provided by the 21- and 50-day moving averages, currently around $83.50.
Ole S Hansen
Head of Commodity Strategy at Saxo Bank