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What's behind the coffee sell-off?
Ole Hansen
Head of Commodity Strategy
Summary: Coffee prices have long been fragile, and yesterday's 7.3% drop – the worst one-day decline since 2010 – underscored Arabica's vulnerability to weather fears and fluctuations in the Brazilian real.
The fragile state of the coffee market was once again put on display yesterday when Arabica coffee futures in in New York dropped by 7.3%, their worst one-day drop since 2010.
The ugly and at times disorderly sell-off came after the market had rallied by 19% since mid-May. The initial rally last month was led by frost fears and a stronger Brazilian real; these developments helped trigger short-covering from hedge funds while also attracting renewed buying from traders looking for the price of beans to bounce from the 2005 low.
A few potential reasons behind yesterday’s move:
• A retreat in the frost fears which helped push the recent recovery to a three-month high.
• A weaker Brazilian real in response to reports that President Bolsenaro's administration is considering ways to relax a government spending cap. The cap is key to investor confidence given Brazil's large budget deficit and uncertainties over pension reform.
• The prospect of Brazil reaping another large harvest in 2020, which is the "on" year in its biennial cycle.
• The International Coffee Organization cautioned Tuesday that the ongoing Brazilian harvest “confirmed its expectation that coffee production in the current 2018-19 season will exceed demand” for a second successive season.
• The contango remains elevated in the futures market with the one-year spread giving short sellers a return of close to 14%. As long as the shape of the curve continues to favour short-sellers, the upside is likely to be limited to periods of short-covering like the one just witnessed.
The key area of support (former resistance) is once again 95 cents/lb but so far the market has managed to hold above 97.33 cents/lb, the 50% correction of the recent run-up in prices.
The ugly and at times disorderly sell-off came after the market had rallied by 19% since mid-May. The initial rally last month was led by frost fears and a stronger Brazilian real; these developments helped trigger short-covering from hedge funds while also attracting renewed buying from traders looking for the price of beans to bounce from the 2005 low.
A few potential reasons behind yesterday’s move:
• A retreat in the frost fears which helped push the recent recovery to a three-month high.
• A weaker Brazilian real in response to reports that President Bolsenaro's administration is considering ways to relax a government spending cap. The cap is key to investor confidence given Brazil's large budget deficit and uncertainties over pension reform.
• The prospect of Brazil reaping another large harvest in 2020, which is the "on" year in its biennial cycle.
• The International Coffee Organization cautioned Tuesday that the ongoing Brazilian harvest “confirmed its expectation that coffee production in the current 2018-19 season will exceed demand” for a second successive season.
• The contango remains elevated in the futures market with the one-year spread giving short sellers a return of close to 14%. As long as the shape of the curve continues to favour short-sellers, the upside is likely to be limited to periods of short-covering like the one just witnessed.
The key area of support (former resistance) is once again 95 cents/lb but so far the market has managed to hold above 97.33 cents/lb, the 50% correction of the recent run-up in prices.
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