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 materialise 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.
Ole S Hansen
Head of Commodity Strategy at Saxo Bank
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