Rate cut a plus for some commodities, but demand and supply forces will still be key

THE commodity sector in general will be supported by the Federal Reserve’s 50 basis point cut as lower rates would reduce opportunity costs for the asset class, increase trading activities and support prices quoted in US dollars.

However, the impact of the rate cut is limited by market fundamentals and structural factors that play more important roles in shifting commodity prices, said market analysts.

Gold prices, which were propelled by market expectations on Fed rate cuts, might be consolidated despite further upside, said Bank of Singapore’s commodity and currency strategist Sim Moh Siong.

Spot gold prices have been hovering around US$2,500 per ounce since end-August. It registered a new high at US$2,579.86 per ounce on Monday (Sep 16) as the market awaited the Fed’s monetary easing announcement, and stayed around US$2,560 per ounce on Thursday, following the news.

The market’s forward-looking nature means the elevated gold prices have priced in the rate cuts. Given Fed chair Jerome Powell’s signal of less aggressive rate cuts after the big move during the press conference, gold prices would see some consolidation if the market is not pricing in more rate cut expectations, said Sim.

“But six months to one year down the road, I think gold prices are going higher partly because the structural factors driving gold prices still stay intact, and that might continue to fly gold up independent of the Fed rate cut moves,” added Sim, noting that the structural factors include geopolitical instability, central banks’ buying and China’s macro concerns.

Gold would continue to shine due to its safe-haven characteristic, and lower interest rates would reduce opportunity cost of holding the asset, said Shaokai Fan, global head of central banks and head of Asia-Pacific (ex-China) of World Gold Council.

“While the Fed rate cut is likely already priced into various asset classes due to its well-telegraphed nature, there remains potential for increased investor interest in gold. In particular, we may see further inflows into gold exchange-traded funds and retail gold products, especially in Western markets,” said Fan.

Oil prices to be lifted in a limited way

On the oil market, rate cuts, however, would only indirectly affect the prices as it secures the US economy’s soft landing. The Petroleum Exporting Countries and its allies’ (Opec+) price balancing act remains the key price mover, noted Bank of Singapore’s Sim.

The crude oil market has been performing poorly amid weakening demand from major importer China and concerns over US recession, despite the Opec+ announcing the rollover of its existing delay on output increase until November, an extension of two months.

Brent crude oil prices had been fluctuating between US$70 and US$100 per barrel since late 2022, until it dropped to US$69.19 per barrel on Sep 10, the lowest since December 2021.

Claudio Galimberti, chief economist of Rystad Energy, noted that while the rate cut can potentially offset the prevailing bearish sentiment in the oil market, the move has little to no effect on China’s economic activities, which is what has spooked the markets lately.

Galimberti noted a 50 basis point cut, stronger than his 25 basis point cut expectation, could mean that the US economy could be in worse shape than what has been depicted so far.

“As for the medium term, I expect the reduction in the interest rate to support economic activity, demand, and lower the cost of carry. All factors are net positive for Brent prices, as long as the reduction in rates goes on for some time and is deep enough,” said Galimberti.

Weaker dollars benefit commodity prices quoted in US dollars

On agri-commodities, a weakened US dollar would benefit those which are quoted in US dollars in both physical and futures markets, assuming other price-moving factors such as the supply and demand of a commodity, currency movements, geopolitical situations, government policies and economic growth remain unchanged, said Rabobank senior analyst Oscar Tjakra.

As importers of these agri-commodities will need to exchange a lesser amount of their local currencies to purchase US dollars to import agri-commodities, import demand for products such as corn, wheat, soybean and soybean meal will increase, noted Tjakra. “This could create positive momentum for commodity prices such as US CBOT corn, wheat, soybean and soybean meal.”

“On the contrary, commodities that are not quoted in US dollars in the futures market, such as palm oil, typically will be less competitive in a weakening dollar environment,” said Tjakra, adding that this might impact export volumes of these commodities negatively.

Market fundamentals play key roles

Analysts believe the impact of the Fed rate cut would be limited by each commodity’s market fundamentals, such as supply and demand.

Victor Arduin, energy and macroeconomic analyst at Hedgepoint Global Markets, noted that the extent of macroeconomic factors’ impact would depend on the strength of the commodity market’s underlying fundamentals, whether bearish or bullish.

“For example, if a commodity has strong bullish fundamentals, a Fed rate cut would reinforce this outlook, but isolating its impact from other factors would be challenging. Conversely, if the fundamentals are solidly bearish, the rate cut would likely have a limited effect on prices,” said Arduin.

He added that while cocoa and coffee prices would be boosted by the rate cut, it would be difficult to isolate the impacts as both commodities are facing supply constraints.

On the other hand, corn and soybeans, currently in a neutral bearish position as the market has already factored in expectations of improved supply, would see a short-lived price reaction as the increased supply could counterbalance the demand boost typically associated with a Fed rate cut.

Fed rate cut paves global rate cuts

The rate cuts need to be more widespread than the Fed alone to have a meaningful effect on commodity prices, noted Darren Stetzel, senior vice-president of agricultural commodities of Asia in StoneX.

“Lower interest rates globally would likely trigger an increase in agricultural trading volumes and ease some of the volatility that many markets have experienced in a high interest rate environment,” noted Stetzel.

He added that one of the main benefits of the Fed rate cut to traders would be a reduction in initial margin requirements, releasing more capital for participants to trade.

“One example has been cocoa where initial margin requirements rose by over 800 per cent since the start of January this year, due to the high interest rate environment that was coupled with a severe supply crunch. A reduction in interest rates should offer some reprieve in the cocoa market as the supply demand balance also regains its footing in the year ahead,” he noted.

Hedgepoint’s Arduin noted that more rate cuts across Asia are expected, after central banks in Hong Kong, Indonesia and the Philippines did so.

“These actions could stimulate economic growth and lead to (local) currency appreciation by 2025, driving higher demand for commodities and supporting their prices. This trend is especially favourable for key markets like grains and metals,” he added.

Reshmi Khurana, partner and managing director of AlixPartners, noted that reduced interest rates also offer an opportunity for commodity players – both upstream and downstream – to access financial support and work on improving their performance.

“This could help provide a buffer for other risks around the corner, especially geopolitical and policy risks, given that the US elections in November are around the corner,” she said.