Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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WCU: Hawkish Fed and China woes send commodities into reverse
Ole Hansen
Head of Commodity Strategy
Summary: The commodity sector turned sharply lower this week as the market reacted negatively to renewed growth concerns after the Federal Reserve Chairman, Jerome Powell, left the market in no doubt that the US would continue to hike rates and keep them high for a prolonged period in order to combat runaway inflation. Adding to this concerns about the outlook for China after a fresh Covid outbreak shut down another mega city. Losses were led by industrial metals with grains seeing the smallest impact.
The commodity sector turned sharply lower this week as the market reacted negatively to renewed growth concerns after the Federal Reserve Chairman, Jerome Powell, left the market in no doubt that the US and other major central banks would continue to hike rates and keep them high for a prolonged period in order to combat runaway inflation. This development helped to drive stock markets sharply lower, while the dollar reached multi-year highs and bond yields climbed back towards the June high. In addition, we saw renewed growth concerns related to China’s prolonged battle with Covid infections and President Xi’s zero-Covid policy after fresh lockdowns were implemented, the most noticeable being Chengdu, a metropolis of 21 million residents.
Both developments turned the focus in commodities back to demand, which may suffer as economic growth slows and away from a tight supply outlook across several major commodities from corn and coffee to diesel and gas, as well as several industrial metals due to mining and production challenges. Growth and China-dependent commodities, such as industrial metals and cotton, suffered a major setback while the prospect for Gazprom resuming gas supplies through its Nord Stream 1 pipeline from Saturday morning helped drive gas prices in Europe lower. With this, gas oil (diesel) fell on the assumption gas-to-fuel switch demand could slow.
Gold, silver and copper
Gold and especially silver suffered steep losses as the hawkish message from several members of the US Federal Reserve and China worries triggered continued headwinds for investment metals through its impact on the dollar – which has jumped 11% against a basket of major currencies this year – while US 10-year real yields have seen their biggest jump in decades, currently up 1.9% in 2022.Demand for investment metals will likely remain challenged until we see the dollar and bond yields stabilise. This might not occur until a deteriorating economic outlook forces a rethink or inflation fails to fall at the pace currently projected by the market. Since Federal Reserve Chairman Powell’s hawkish speech at Jackson Hole last Friday, forward inflation expectations have declined further with the inflation swaps out to five years now all pointing to inflation below 3%.
Silver has seen the biggest decline as it continues to find directional inspiration, not only from gold and the dollar, but recently (more importantly) from industrial metals, especially copper. Both metals are currently down 24% year-to-date with silver having returned to a previous consolidation range between $16.50 and $18.50. The result being a jump in the gold-silver ratio to a two-year high around 95 (ounces of silver per ounce of gold). The ratio has now retraced more than 50% of the 2020 to 2021 collapse from 127 to 62 with a recovery much depending on China and copper developments.
On copper supply, it is worth mentioning that copper slumped 8% in a week that saw production in Chile, the world’s top producer, drop for a second month with mines struggling with falling ore-grades meaning mines need to move more rock to produce the same amount. In addition, water restrictions have presented further headwinds for producers. Developments that could see copper and with that silver recover strongly once developments in China improves.
Gold’s ability to act as a diversifier has increasingly been called into question with the latest decline to near the key support area of around $1680/oz.
Once again, however, it is worth highlighting that gold – except for XAUUSD which has been troubled by the mentioned 11%-dollar rally – continues to do a great deal better than under pressure stocks and bonds. The yellow metal has so far once again managed to find support around $1680, an area that has provided support on several occasions during the past two years. A break to the downside would sour sentiment further and may challenge investors with a long-term positive view on the metal. At this stage the price needs to break above the trendline from the March peak, currently at $1770, before signalling a recovery.
Gold’s ability to act as a diversifier has increasingly been called into question with the latest decline to near the key support area of around $1680/oz.
Once again, however, it is worth highlighting that gold – except for XAUUSD which has been troubled by the mentioned 11%-dollar rally – continues to do a great deal better than under pressure stocks and bonds. The yellow metal has so far once again managed to find support around $1680, an area that has provided support on several occasions during the past two years. A break to the downside would sour sentiment further and may challenge investors with a long-term positive view on the metal. At this stage the price needs to break above the trendline from the March peak, currently at $1770, before signalling a recovery.
Crude oil rangebound, but volatile
Crude oil’s bounce from a six-month low became unstuck following Jerome Powell, the Federal Reserve Chairman’s hawkish message. Together with renewed lockdowns in China, it once again triggered a reversal in the market focus away from tight supply and back to worries about demand. What followed was a near 12-dollar correction to near $90 in Brent and $85 in WTI with some of the selling being driven by speculators having bought the break above $100 following Saudi comments that OPEC+ could consider a production cut.In Europe and increasingly also Asia, elevated prices for gas and power continues to attract substitution demand into fuel products like diesel and heating oil. In the short-term, the price of gas into the autumn months will continue to be dictated by Russian flows, and not least whether Gazprom (and Putin) will resume flows on the Nord Stream 1 pipeline as announced, following the three-day maintenance shutdown that ends at 0100 GMT on September 3.
On the supply side, the market will be watching the impact of the EU embargo on Russian oil, which will begin impacting supply from December and the 180-million-barrel release, at a rate of one million barrel per day from US Strategic Reserves that look set to end on October 21. Finally, an Iran nuclear deal has yet to be reached, and after the US called Iran’s response to the latest effort to revive the 2015 nuclear as “not constructive”, the risk of failure remains. Following a 25% drop in US retail gasoline prices since June and the Democrats not wanting to be seen as going soft on Iran, a deal looks increasingly unlikely, at least in the short term.
With OPEC+ meeting to talk output on September 12 the price of oil is unlikely to fall further with support at $85.50 in WTI and $91.50 in Brent unlikely to be challenged soon.
EU gas and power prices drop on hopes for resumed Russian supply
The European energy market have reversed some of the recent strong gains in gas and power prices following a recent surge that was driven by robust demand for pipeline supplied gas after low water levels on the river Rhine prevented normal shipments of coal and diesel to utilities and industries in the German heartland. However, it was a three-day shut down for maintenance on the important Nord Stream 1 pipeline which sent prices surging on fear supplies would not resume at 0100 GMT on 3 September – the time Gazprom had announced the reopening would occur.However, as the week wore on, the risk of a non-opening faded and Dutch TTF gas tumbled to near €200 per MWh while German Year ahead power more than halved after briefly surging above a €1000 per MWH on Monday. In response to these eye-popping and growth killing power prices, the EU is preparing to intervene and adjust the price setting of power prices within the region. The recent turmoil has also added fuel to concerns trigger happy speculators with deep pockets – the initial margin on one German Year ahead futures contract is around €1.8 million – have been able to drive prices to levels unjustified by current fundamentals, only to dump positions once panic buying dried up.
With EU storages filling up and provided gas returns via NS1, we could see gas prices drop below €200/MWh – a level still high enough to support rationing and demand destruction.
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