While market debates commodities bottom, inflation warnings rise
Some traders have been ringing the bell for the bottom of the commodities collapse, just as markets are sniffing out the earliest signs of inflation.
That's important since a turn in commodities prices could mean a pickup in inflation, which is already starting to materialize, and that could get the Fed moving faster on interest rate hikes. Fed funds futures on Monday began to price in a full rate increase for December, for the first time since late January. Futures had been pointing to the first rate hike in March 2017.
"Services inflation has remained steady for a while. All you needed was commodities prices to stop going down and that changed the inflation calculation here," said Peter Boockvar, chief market analyst at The Lindsey Group. He said core CPI has been 2.2 percent and inflation could easily rise more broadly if commodities hold and build on gains. The PCE deflator, the Fed's preferred inflation measure, rose to 1.7 percent recently, faster than the central bank had forecast.
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Fed Vice Chairman Stanley Fischer on Monday acknowledged the Fed is not too far from meeting its target for inflation, the side of its dual mandate that has lagged while employment has been strong. That has also allowed the central bank to bide its time while monitoring the global economy and impact of financial market turmoil.
"I think you have a situation where all you need is oil prices to stop going down, and the rate of change starts going higher. You'll have north of 2 percent in headline inflation by the second half of this year," said Boockvar. "I think Stanley Fischer is acknowledging it."
The recent run of better-than-expected economic news, like Friday's report of 242,000 new jobs in February, and better durable goods orders and ISM manufacturing data, have all been changing the market's perception of Fed rate increases. Before the PCE was reported Feb. 26, the market was expecting just about a 35 percent chance of a Fed hike in December, but that has clearly changed and Friday's jobs report gave it a final push.
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As fed funds futures have finally moved to price in a rate hike for 2016, Treasury yields have also shifted higher. The Fed-sensitive was as high as 0.91 percent Monday. While there is little data to move yields this week, there are three key auctions, starting with the $24 billion three-year note auction Tuesday at 1 p.m. ET. There are 10-year and 30-year bond auctions Wednesday and Thursday, respectively. There is a report on small-business sentiment at 6 a.m. Tuesday.
Stocks rose Monday, with the at 2,001, a less than 2-point gain. Oil helped put a bid in equities, with West Texas Intermediate crude jumping another 5.5 percent to settle at $37.90 per barrel, its highest settle since Dec. 24.
While there's been a surge in some commodity prices, analysts are divided on whether a bottom is in.
"I think it's an open debate whether or not an upward trend has started, but I do think we've seen the bottom. I think what commodities markets are trying to do right now is carve out a trading range. That's the current state," said Ward McCarthy, chief financial economist at Jefferies.
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McCarthy expects the Fed to next raise rates in June and then hike again before the end of the year. "The rocky road to normalization is paved with inflation," he said. "We've already seen I think a bottom (in commodities). I think it's going to be choppy for a while but by the end of the year, we'll be above 2 percent on the CPI and that will not be transitory. That will be a significant development."
Commodities have been lifting off, but at different paces. Copper futures are up 6.7 percent since the year began, while gold futures are up nearly 20 percent. Oil, meanwhile has been on a tear with WTI up 45 percent from its Feb. 11 low of $26.05.
The 20 percent jump in iron ore prices in Asia on Monday spurred more talk about whether commodities are ready to turn higher. Iron ore surged to a nine-month high as China's National People's Congress met, sending out dovish signals and speaking about spending on the economy. But Goldman Sachs analysts were skeptical and said in a note that the gains won't last unless there's a significant pick up in Chinese steel demand. Ore was reported to have risen to $63.74 per metric ton in Qingdao.
"I think it's premature on the bigger picture. I'm still not certain on the oil for one and copper for another, and whether these are just some major short covering rallies," said Peter Hug, global trading director at Kitco. "These commodities have just been slammed. ... It's early days. Nothing has really changed. I didn't see anything overnight where everybody should be optimistic."
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Christopher Louney, commodities strategist at RBC Capital Markets, said he too believes it's too soon to say whether commodities have turned though the influx of funds into them has been dramatic.
"What we saw at the end of 2015, especially in November and December, for commodities investors were the worst months," he said. "The dismal duo. They were the weakest in recent memory. The first quarter will be incredibly important once we get the final data for March. Since the beginning of the year, we've seen a big increase in AUM."
Gold makes up the majority of assets under management in precious metals, and that sector has seen AUM rise to $86.8 billion in February from $73.5 billion in December. But Louney, in a note, pointed out that the holdings had peaked at $183.5 billion in November 2012.
"We had a very strong January and a very strong February but it's been on the back of a single commodity," he said in an interview.
"We really need a sustained assist from energy to really drive the complex higher," he said, noting that it will be oil that determines whether the bottom is in for the commodities complex.
Whether crude has bottomed is also up for debate. "We did expect the weakest part would be this quarter," said Michael Cohen, head of energy commodities research at Barclays.
He said there were some supply disruptions in exports from Iraq and Nigeria.
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"From the supply side, you add to that the discussion over the freeze. That helped alleviate the bearish sentiment on the supply side," he said. "On the demand side, we're still in the midst of the refinery turnarounds. I don't think we're out of the woods yet. We could see a correction once we're out of the shoulder season, but I think the market is looking forward to a tightening in the second half."
During the shoulder season, refiners use less oil as they turnaround their facilities to produce summer-grade fuels.
There has also been talk that Gulf producers are looking for a $50 oil price, to help sustain government spending and prevent ratings downgrades.