Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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WCU: China buying lifts ag sector hopes
Ole Hansen
Head of Commodity Strategy
Summary: Commodities led by agriculture and industrial metals trade higher for a third week as US and Chinese leaders look to lower tensions ahead of October trade talks. Gold remains supported despite rising yields while crude oil struggle amid the risk of an emerging supply glut.
The Bloomberg Commodity Index has traded higher for a third week and during this time all three sectors have taken turns in the lead. In late August it was precious metals which surged in response to falling bond yields and reduced risk appetite. A thaw in the US China trade relations then helped trigger a strong week for crude oil and HG copper before the agriculture sector, following weeks of selling, moved higher last week.
Grains found support after a government report lowered the expected output from the coming harvest, together with renewed Chinese buying of soybeans. Precious metals continued to consolidate with gold finding support despite the recent 35 bp rise in US ten-year notes to 1.8%, a five-week high. Industrial metals maintained a bid amid optimism over signs of easing trade tensions. Crude oil markets meanwhile quickly reversed their recent gains with OPEC and Russia at a meeting in Abu Dhabi struggling to find a response to the current slowdown in demand, something that led the International Energy Agency to warn about a looming supply glut into 2020.
Ahead of the expected rate cut from the US FOMC next week the ECB gave the market an opportunity to test current market themes and assumptions. However, after delivering several measures to stimulate the economic activity, the subsequent market reaction took most by surprise. The euro rallied strongly, and bond yields jumped after it emerged that key core countries Germany, France and the Netherlands objected against the new QE. We conclude that the ECB has reached the end of the road in terms of what it can do with fiscal policies potentially taking over.
Ahead of the early October trade talks between the US and China, both countries have made steps to improve their relationship thereby raising market expectations for a breakthrough. US agriculture products have for the past 18 months been caught in the crossfire, but this past week China was seen in the market buying US produced soybeans, cotton and hogs. This comes at a time where hedge funds are holding net-short positions in all but a couple of the major agriculture futures markets.
Hopes were raised ahead of the OPEC+ JMMC meeting in Abu Dhabi that the group would do more to support the price of oil. This after Saudi Arabia, in need of $80/b to balance its budget, appointed oil veteran Prince Abdulaziz bin Salman (ABS), as its new Energy Minister. Despite promises from Iraq, Nigeria and Russia to cut production to their agreed target levels, the market again turned lower. This after monthly oil market reports from the three major forecasters all raised concerns about the continued decline in global demand growth. Something that led the International Energy Agency to warn that the market may face a looming supply glut into 2020.
Brent and WTI crude oil’s attempted breakout lasted less than a week and both have returned to their respective ranges around $60/b and $55/b. We suspect that nervous rangebound trading will continue with any renewed risk-off from failed trade talks or deteriorating economic data keeping the market on the defensive.
Gold’s high correlation to US bond yield movements has triggered the first major challenge to the rally that began back in June when bond yields turned sharply lower. While the short-term risk of a correction to $1450/oz or in worst case scenario $1380/oz exist, we maintain a bullish outlook for gold. We view the current setback, however painful, as being necessary to breathe fresh life into a rally that had gone stale.
Previous bull markets in gold, most noticeable the one from 2000 to 2010 were littered with aggressive corrections which despite the strong gains that decade made it a difficult market to trade for short-term tactical traders. The reasons behind our bullish view on gold and precious metals in general are:
- The US Federal Reserve is likely to continue to cut rates
- US-China trade war is raising recessionary risks
- Nominal and real bond yields are expected to stay low and, in some places negative. Thereby removing the opportunity cost associated with holding a non-coupon and non-interest paying asset
- Continued buying by central banks looking to diversify and for some to reduce the dependency on the dollar, so called de-dollarization
- The dollar is potentially on its final legs with the emerging risk of US action to weaken the Greenback
The chart below shows the risk of a retracement back towards the $1450/oz, a level which would still only reflect a weak correction within a strong uptrend. It would take an unlikely break below $1380/oz, the multi-year resistance area turned support, for the technical outlook to turn back to negative.
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