Let’s look at how commodity prices are faring in the lead-up to Wednesday’s rate announcement by the U.S. Federal Reserve.
The August U.S. unemployment rate rose by 0.2 of a percentage point from the previous month to 3.7 per cent and the number of unemployed persons increased by 344,000 to six million. That increase, announced on Sept. 2, in the unemployment rate gave the markets breathing room until Consumer Price Index (CPI) numbers came out.
The U.S. CPI numbers for August were revealed on Sept. 13 and the “all items” category was 0.1 per cent higher month over month and up 8.3 per cent year over year. Economists had expected a decrease of 0.1 per cent month over month, especially with the drop in gasoline prices. Although it was a small difference, that increase had a huge impact on the markets, commodities and interest rates.
The numbers immediately caused an increase in the projected Fed fund rate. The U.S. market is now pricing in interest rate hikes of 75 basis points (0.75 of a percentage point) by the U.S. Federal Reserve on Wednesday, 75 basis points in early November and 50 basis points in December. That means U.S. interest rates could rise by two percentage points over the next three months, followed by a smaller expected hike of 0.25 per cent in March, 2023, pausing at the 4.5 per cent to 4.75 per cent range (from the current 2.25 per cent to 2.5 per cent).
Immediately after the CPI results were announced, most commodity prices fell, with crude oil declining almost 4 per cent, gold off 2 per cent and copper down more than 4 per cent.
With the rise in natural gas prices in Europe, some power generating companies are switching from gas to oil. That shift is causing upward pressure in oil prices. Offsetting this, OPEC+ made a small cut (100,000 barrels a day) to oil production. Expectations are that oil could see a relief rally over the next month followed by a decline to as low as US$60 a barrel owing to weakened demand during a recession. Crude oil prices retreated last Thursday after the U.S. Department of Energy said it does not need a price trigger to restock the Strategic Petroleum Reserve (SPR) and doesn’t plan on refilling it until after its fiscal year-end, Sept. 30, 2023. (Crude prices had rallied last Wednesday after a Bloomberg report said the Biden administration was considering buying crude oil to refill the SPR when prices fall below US$80 a barrel.)
Natural gas prices in Europe are significantly off their recent highs of late August, falling from €325 ($432) to €200 ($266) a megawatt hour. There are a number of continuing actions being taken there to curb prices including reduced power consumption, price caps and switching fuels. In North America, natural gas prices have also fallen, about 15 per cent from the peak in late August to US$7.76 a British thermal unit, but prices are up 45 per cent year over year. Increases in natural gas consumption by the U.S. electrical utilities sector, the largest consumer of natural gas, has occurred this year, partially owing to a switch from coal power generation.
Wheat prices have come down from recent highs with supply improving and shipments from Ukraine and Russia increasing. Wheat would have been affected by a U.S. railway strike that seems to have been averted, as most Midwest wheat moves via rail. Trading Economics estimates wheat to trade at US$9.78 a bushel in 12 months’ time, up 16 per cent from current levels.
The price of gold currently sits at a 29-month low. Its price has been falling because of higher interest rates and a strong U.S. dollar, in which gold is priced. In inflationary times the yellow metal is considered a hedge, but the sharp rise in rates has more than offset the benefit gold experiences during periods of negative real interest rates (nominal or stated interest rates minus inflation).
Copper has also been falling since spring as recessionary fears continue and demand from China slows. In the short term the price of copper has been rising since mid-July amid signs of physical tightness, hopes for more Chinese demand and risk of a strike at BHP Group Ltd.’s Escondida mine in Chile.
Other base metals, including aluminum, nickel, lead and zinc, are down since their peak in March owing to increased fears of recession. Zinc prices have seen some strength recently because of decreased global production and reduced smelting because of higher energy costs and Chinese restrictions.
Lumber is another commodity that is affected by recession, especially during rising interest rates that hamper mortgage demand. U.S. new home sales in July dropped to their lowest level since 2016. Lumber prices have been holding in the US$500 range per 1,000 board feet as the weakened demand has been offset by seasonal downtime for maintenance by sawmills.
With this backdrop of rising rates, reduced demand, recessionary fears and weakening consumer confidence, we continue to expect further softness in commodity prices for the balance of 2022 into 2023.
Brian Donovan, CBV, is the president of StockCalc, a Canadian fintech based in Miramichi, N.B.