A NEW commodities boom is complicating central bankers’ anti-inflation efforts, and may derail prospects for significant interest rate cuts any time soon.
Even before Iran’s attack on Israel over the weekend (Apr 13) stoked fears of a wider regional war and disruption to oil supplies, crude oil had already risen significantly this year. That advance, together with a renewed exuberance in markets for precious metals and other raw materials, has pushed the Bloomberg Commodity Spot Index to an almost seven-month high.
The rally in oil makes petrol costlier in the US, where pump prices are a political hot-button issue, especially in an election year. Copper, which is essential for wiring, plumbing and industrial machinery, is at highs last seen in mid-2022. Coffee prices have also leaped this year, while cocoa’s surge to an all-time high has thrown the chocolate industry into disarray.
Last week, the US core consumer price index (CPI) rose more than expected, delaying expectations for a US Federal Reserve rate cut. Two of the biggest drivers were petrol and electricity prices.
“This latest rally makes it much tougher for central banks to ease interest rates,” said Trevor Woods, chief investment officer of Northern Trace Capital, which is long across several commodities.
Investors are piling back into exchange-traded funds (ETFs) that track commodity indices, with the 20 largest, broad-based commodity ETFs pulling in roughly US$1 billion since the beginning of March, data compiled by Bloomberg indicated. At the same time, investors who fled commodities during the late-2023 sell-off are now jostling to get back in.
GET BT IN YOUR INBOX DAILY
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
“Stickier-than-expected inflation is a big part of commodity inflows, creating demand for portfolio hedges,” said Ryan Fitzmaurice, a senior commodities strategist at Marex. “A rotation back into commodities would not surprise me, given the recent CPI misses.”
While the commodities sector comprises a diverse group of raw materials mined, extracted or harvested across practically every time zone, many of the most significant index components are rallying strongly at the same time. Higher raw-material prices are feeding into inflation and threatening to keep it elevated for longer.
Oil – the biggest and most consequential commodity market – has climbed this year amid escalating conflict in the Middle East, coupled with higher-than-expected demand and flat supplies. Last week, Brent crude traded at more than US$92 a barrel for the first time since October.
Industrial metals with a role to play in electric cars and data centres also are having a moment. But no commodity’s year-to-date gains even approach the more than doubling in cocoa that has candy makers shrinking packages and chocolate lovers bracing for the worst.
Collectively, this all adds up to higher prices for consumers. Pacific Investment Management recently warned that the Fed could resort to rate hikes if inflation keeps running hot. Markets currently see rates at about 4.9 per cent when the Fed convenes in December – that compares with an expectation of 3.8 per cent at the start of this year.
Conversely, gold has been hitting fresh highs on an almost-daily basis, as increasing anxiety about inflationary pressures drives investors into safe-haven assets.
The renewed appetite for commodity investments partly shows up in the total value of derivatives contracts in the sector that traders are holding. That climbed to a seven-month high of US$1.4 trillion at the end of March, observed JPMorgan Chase.
“The Fed could take its time easing rates; and if they stay higher for longer, we’ll probably see other central banks around the world ease before we do,” said JD Joyce, president of Joyce Wealth Management in Houston.
To be sure, not all commodities are rallying. Natural gas prices in the US have been so low that some producers are shutting wells. Other than cocoa, many agricultural markets have been softer on ample supply prospects, meaning less risk to food prices around the globe.
Nor is it certain that oil can rally much further from here, even if tensions continue to mount in the Middle East. Despite Iran launching more than 300 missiles and drones at Israel, Brent crude prices were little changed when trading resumed in Asia on Monday.
“Any rise in oil prices on higher geopolitical risks may be dampened by oil producers deciding to hedge their price risks and sell forward their production,” Goldman Sachs Group analysts said on Sunday in a note.
How long will the current commodities rally last? Although analysts at Macquarie Group said last month that energy and commodities are entering the “the first throes of a cyclical upswing”, most observers are not calling this the beginning of another super cycle.
If input prices get too high, that can ultimately damp consumer demand for finished goods. And any kind of economic slowdown due to inflation could be bad news for President Joe Biden, as he tries to convince voters he has managed the economy well during his time in the White House.
“Commodities are the significant input for many industries, and rising prices will start to hurt growth if higher prices are not able to be passed along to consumers,” said Rebecca Babin, senior energy trader at CIBC Private Wealth. BLOOMBERG
Keyword added to your list