In its June 14-15th meeting, the Federal Reserve hiked interest rates by 75 bps to a range of 1.5% – 1.75%. This was above Chairman Powell’s planned hike of 50 bps, and the largest increase since 1994.
However, this decision was not entirely unexpected in light of an eye-watering CPI print of 8.6% the week before.
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Crucially, Chairman Powell has signaled that he would continue to increase rates this year.
The Fed has assumed a much more hawkish tone indicating its seriousness in combating record levels of inflation to re-establish credibility.
At the same time, communication from the Fed has been positioned for maximum flexibility going forward, with the Powell stating that “Our guidance is always conditional on what happens. It is an unusual situation…”
Did the commodity market see this coming?
Many large financial institutions such as Goldman Sachs, JP Morgan, and Barclays had already raised their expectations to a 75-bps hike.
Financial markets too seemed to have priced in this jump as equities, bonds, and cryptocurrencies faced sharp sell-offs after the CPI release.
On balance, the market seemed to be convinced that the Federal Reserve would see the urgency of a bigger hike, and respond accordingly.
Zach Griffiths, senior macro strategist at Wells Fargo said that “to change their view and their action to 75 basis points from 50 basis points is a big move in a short time. But it makes sense to us given the current economic backdrop.”
However, not everyone was of this view.
For instance, Neil Dutta of Renaissance Macro Research felt that deviation from the stated path would show that “the Fed is losing confidence in its forecast” and would signal that officials are now “panicking”.
In a bit of a twist, Esther George, a well-known policy hawk, was the only member of the FOMC who batted to stay the course and hike by 50 bps.
Other than the fresh CPI highs, the release of the University of Michigan’s consumer sentiment index, showed that 46% of consumers blamed inflation for deteriorating business conditions.
Respondents expected inflation rates to rise 5.4% over the next year. Long-term inflation expectations also rose to 3.3% which was the highest on record in over a decade.
Similarly, the New York Fed’s Survey of Consumer Expectations found that inflation expectations rose to 6.6%, the highest on record since 2013.
Since inflation expectations are core to the Federal Reserve’s views on inflation, the hope is that above-stated rate hikes will likely prevent any further de-anchoring.
How did commodities respond?
It is difficult to ascertain the effect of monetary policies on the markets in such a short window of time. However, after about a day, the performance of major commodities has been mixed.
The graph below shows the price movements among key commodities post the CPI release, close prior to the Fed meeting, and year-to-date performance, at the time of writing.
The unexpected surge in CPI to a new four-decade high had forced a sell-off in major commodities. WTI crude fell 1.4% from the close on Friday, the 10th of June to the close on Tuesday, the 14th. Gold and Copper both fell by more than 3%.
Natural Gas was an outlier, declining nearly 19%, due to the unexpected shutdown at the LNG terminal in Freeport, Texas.
The rising inflationary pressures signaled the likelihood of accelerated monetary tightening by the Federal Reserve, and fears that hiking rates when consumer expectations in the US were already weakening, may lead to a global recession or worse.
Even the yield curve inverted on Monday, the 13th, raising concerns of a deep slow down.
At the time of writing, gold, natural gas, and copper prices increased 1.1%, 5.2%, and 0.5%, over the closing price a day before the Fed meeting.
This is likely due to several factors. Firstly, commodities may have been oversold last week after the surprise announcement of accelerating inflation.
In recent times, the Fed’s credibility has been questionable, leading to market uncertainties.
However, with Chairman Powell’s decisive shift to a higher rate future, confidence in the Fed may have been restored to an extent.
Global commodity companies and traders are now fairly certain that they expect the Fed to continue to raise rates to tackle inflation, at least till the end of the year.
This has brought some clarity to the markets in terms of their projections and investment decisions.
Oil price reaction
Prices were in the green on the morning of Thursday, the 16th, rising approximately 1% for both WTI and Crude. The International Energy Agency (IEA) forecasts global demand to exceed pre-pandemic levels in 2023. With disruptions in Russia, shortages will likely persist re-enforcing the picture of additional rate hikes.
Rising prices may also provide the impetus to boost operating rates at under-used refineries, with capacities expected to improve by 1 million barrels per day (bpd) by the end of the year.
Downside risks to China’s economy due to a new wave of covid cases were more than balanced by the unexpected rebound in industrial production data in May, rising 0.7% on annual basis, after a sharp contraction in April.
Brent and WTI are 52%-54% higher on a YTD basis.
Gold price reaction
The yellow metal surged after the Fed’s announcement, rising from $1,815 at 2 pm on Wednesday, the 15th, to a high of $1,845 before closing at a nearly even $1,819.
Often seen as an inflation hedge, gold spiked as the Fed was forced to revise its inflation projections upwards.
Further, seen as a source of security during market uncertainty, gold saw a strong uptick as Jerome Powell admitted that “events of the last few months have raised the degree of difficulty” of a soft-ish landing.
At the time of writing, gold prices are approximately $10 higher for the day, near $1,830 levels.
Natural Gas price reaction
NG prices in the US have been weakening for two weeks, falling to a 5-week low a day prior to the Fed meeting.
Prices have rebounded sharply by over 5% in the past 24 hours, driven higher by projections of record heat waves across vast portions of the United States and Europe.
Globally, prices are also higher due to Russian supply stoppages to parts of Europe.
At the time of writing, Natural Gas prices were higher by 111% year to date.
Copper price reaction
As a gauge of the health of the global industry, copper prices have been in decline since mid-April.
After the Fed hike, prices improved to a daily high of $4.2040, to reverse some of last week’s losses.
However, prices ended nearly even yesterday, and have declined 0.7% so far this morning.
At the time of writing, prices are 9.3% below the monthly high recorded on the 2nd of June.
With operating rates improving in China amid the broad unlocking, and the raising of power consumption limits, trades are optimistic that prices and output are both likely to improve, lifting business optimism.
What is next for commodity prices?
Despite the looming threat of a recession, Chairman Powell made it clear that an option of raising rates by 75 bps was very much on the table for the Fed’s next scheduled meeting.
Daniella DiMartino Booth, CEO of Quill Intelligence and former Fed insider stated that housing CPI “will continue to tick up and be very problematic for the Fed, even if discretionary inflation” begins to come down.
She believes that hiring freezes and job losses would bring down discretionary spending, but
“The stickiest form of inflation, and that is housing, is not coming down any time soon.”
Greg McBride, Chief Financial Analyst at Bankrate, stated that the Fed’s “job is going to get tougher the more they push up rates, especially if inflation remains stubbornly high”.
Despite these warnings, the market largely took comfort in the Fed’s actions, with DiMartino Booth suggesting that investors “wanted to know that Jay Powell was going to be as close to Volcker as he could be.”
Given the market’s new-found confidence in the Fed, rising demand, and geopolitical tussles, commodity prices are likely to continue to rise for the foreseeable future.
However, any such comparisons with Volcker may be pre-mature with debt levels being a third larger than GDP in the US at this time.
Luca Paolini, the Chief Strategist at Pictet Asset Management, pointed to an interesting data point. During the past half-century, when oil prices adjusted for inflation, have risen to 50% above trend, a recession has ensued.
Sounding alarm bells, Paolini warns that Brent prices have not been below this level since early May.
Many of the factors that are influencing inflation are beyond the control of the Fed, especially the war in Ukraine, and supply disruptions.
In this uncertain environment, Powell and company will likely tailor communication to keep all policy options open for as long as possible.
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