Rate hike expectations slay commodities

Ravindra Rao, VP - Head Commodity Research, Kotak Securities

Commodities are set to end the week with steep losses as the US dollar (USD) once again emerged the winner in times of uncertainty.

The uncertainty this time is triggered by hawkish comments from major central banks and renewed Covid concerns in China. Amid increasing challenges, market players are waiting for the European Central Bank’s (ECB) meeting next week, which will set the stage for the US Federal Reserve’s (Fed) meeting on September 20-21.

Gold slipped below the key $1,700 per troy ounce level and is set for its third week of losses, amid a stronger USD and higher bond yields. Crude oil slipped more than $10 from the highs set earlier this week as market players shifted focus from supply risks to demand concerns. Industrial metals also noted sharp losses led by zinc, with an improvement in the energy situation and renewed spread of Covid in China.

The USD reached a fresh high as market players shunned riskier assets amid increasing uncertainty about the global economy. The Fed’s monetary tightening, and higher bond yields, have also underpinned the USD.

The Fed has been raising interest rates since March and has maintained that its priority is to get inflation under control. Despite this, market players debated the possibility of slower rate hikes as the economy showed signs of stress and the inflation showed signs of improvement.

With hawkish comments from Fed chairman Jerome Powell and as well as other Fed officials, market players are repositioning their rate hike expectations. Fed officials have indicated that rate hikes may continue until inflation comes under control, even if it results in some slowdown in economic activity. If we look at Bloomberg estimates, market players are expecting a third 75-basis-point rate hike at the upcoming meeting this month.

Comments from Fed officials indicate that the central bank may not alter its stance unless the inflation reduces significantly or the economy slows down sharply. The inflation has improved but still remains elevated. Economic data highlights stress in the economy even as the labour market remains strong.

While the Fed’s continuing monetary tightening is positive for the USD, hawkish comments from ECB officials raises questions about further hikes. A number of ECB officials have expressed the need to take aggressive measures to control inflation.

While the USD is running the show, concerns about the Chinese economy have intensified.  China’s continued shutdowns to contain Covid is hampering economic activity in the region.

In the latest such shutdown, around 21 million people in the city of Chengdu have been ordered to stay indoors. Other restrictions are currently in force in Shenzhen in the south and Dalian in north-east China.

Manufacturing data from major economies also added to demand concerns. China, UK, and the Euro-zone manufacturing PMI (purchase managers’ index) remained below 50, indicating contraction in the sector. On the other hand, US manufacturing PMI was better than expected.

Commodities were also hit due to some improvement in the power situation in China, and correction in energy prices. Power supply returned to normality in southwest China's Sichuan and Chongqing regions.

Dutch TTF gas prices slumped more than 30 percent from March highs as Germany indicated that stocks may reach target levels before deadline. However, concerns about Russian supply led to some stability later in the week.

Commodities have witnessed sharp losses as demand concerns have been coupled with firmness in the USD and easing gas and power concerns. The sell-off has dented market sentiment and we may not see significant improvement unless the USD corrects sharply or until there is significant improvement in China’s Covid situation.