By Ulf Bergman
The release of the US Federal Reserve’s meeting minutes on Wednesday took much of the wind out of the sails for the global financial markets. There is a growing consensus among the decision-makers at the US central bank that its stimulus measures put in place to support the economy needs to be scaled back, as they expect the US economy to be able to sustain itself. This contributed to a sense of unease among investors worldwide at the same time as the strength of the continued recovery is being questioned, in light of the renewed spread of the virus. The reduction of liquidity and availability of cheap money by the central bank would remove some of the speculative pricing support that many financial assets and commodities have enjoyed in recent months, something that weighed heavily on Thursday’s trading session.
The increasingly mixed fortunes confronting the global economy are adding to the complex picture, which central bankers and politicians have to deal with. The US labour market continues to recover, despite a rapid spread of the delta variant of the coronavirus, and registered a fourth straight week of declining claims for unemployment benefits and are now less than half of what was seen in January. The labour market data were released after the minutes from the latest Fed meeting were made public, but are likely to reinforce the perception of a necessity to taper the stimulus programmes or face rapidly rising inflation. Especially as the employment revival is moving at a faster pace than has been expected by many pundits and it could see parts of the US economy facing the risk of overheating unless the continued growth is tempered somewhat. At the same time, the rising number of infections, both in the US and globally, could threaten global trade and economic growth. The increasing degree of uncertainty has also seen the US fear factor, the VIX, increasing in recent days, as market volatility is on the rise.
Chicago Board Options Exchange Volatility Index
On the other side of the Pacific, the Chinese authorities are facing a different set of challenges with economic data increasingly failing to meet expectations. Confronted with a plateauing economy, Beijing has targeted high commodity prices, with iron ore and steel being at the receiving end of much of the ire. The clampdown on steel production in recent weeks, through export tariffs and production quotas, has seen iron ore prices falling to levels not seen since the end of the first quarter and erasing this year’s price gains. It is, however, important to remember that this is to a great extent an inflation control move from the Chinese authorities, who have previously been vocal in their criticism of stimulus programmes and their effects on commodity prices. This should also be seen in the light of China’s increasing focus on the stability and independence of the domestic economy, as part of the dual circulation policy in the current five-year plan. The stated goal of the Chinese leadership is that the current year’s steel production should not exceed last year’s record levels, to control the steel industry’s emission levels. There are also pressures on Chinese steel producers to focus on the domestic economy, rather than the export markets. However, challenged with a stagnating recovery there might be a temptation to allow for production to increase moderately in the coming months. After all, the original objective of bringing the iron ore prices under control has been largely successful.
It is not only iron ore that has seen large parts of the year-to-date gains erased in recent weeks, copper has seen its gains dropping from 35 per cent in May to fifteen per cent on concerns of a more problematic global recovery than expected and an improving supply situation. The improving sentiment in the crude oil market has also taken a hit, as the outlook for international travel has dimmed with the resurgent pandemic. Improving weather conditions for the farmers across the American Midwest has also boosted the outlook for the soybean harvest, which previously was under threat due to extreme heat and lack of rain, and seen prices for the crop retreating to where they began the year. While there are concerns that the new outbreaks of Covid in China, the world’s largest importer, will affect its demand for the crop in the coming months, the falling prices should make it more attractive for feed after many Chinese pig breeders began using alternatives in light of soaring prices during the first five months of the year.
Soybeans US cents per bushel
The Phase One trade deal, that was concluded between the US and China at the beginning of last year, has so far not been a runaway success. For imports of US manufactured goods and energy, China is lagging well behind the volumes implied by the agreement and the probability of meeting the targets for the year is looking increasingly slim. However, for agricultural commodities, there is a realistic chance that the import goals could be met. According to data from the Peterson Institute for International Economics, US exports of agricultural products were at 90 per cent of the target at the end of June. While the trade agreement is focusing on the value of exports rather than the volumes, the drop in prices for soybeans and other crops would give the Chinese buyers better value for money, but also increase the volumes shipped if they were to live up to their commitments under the deal. Based on the baseline levels of 2017, US agricultural exports to China can be expected to pick up during the second half of the year as the new harvest gets underway.
Assuming that the Chinese will keep their end of the bargain, the declining prices of soybeans and other crops would mean that the shipping sector could see increasing tonnage demand. Hence, suggesting that the level of the commodity prices are not a good leading indicator for freight rates. Rather than being a function of the commodity prices, freight rates are generally a reflection of the volumes shipped and available tonnage. There have been suggestions that the falling iron ore prices are bad news for the freight market and it could be true if the drop is related to a genuine slump in demand. However, there is at this stage little to suggest that iron ore is facing an imminent drop in demand and improving supply situation and less speculative pressure could keep prices low. The lower iron ore prices could see larger volumes being shipped, while bad for the miners it is good news for the shipowners. There are also other factors at play, such as the current diplomatic spat between China and Australia. The Chinese desire of reducing its dependence on Australian iron ore is seeing increasing volumes of iron ore shipped from Brazil to Chinese ports and tying up vessels for longer.