Lumber Could Crash With High Rates and Slowing Housing Market
Random-length lumber futures trade on the CME, but the contracts have never gained the critical mass necessary to make wood a liquid hedging tool. Lumber futures are a benchmark that moves higher and lower with economic conditions. Before 2018, the all-time high was at the 1993 $493.50 high. On August 11, in an article on Barchart, I pointed out that the lumber futures price did not fall below the August 2021 $448 low. On September 1, the price of nearby futures was above that price, but the trend remained lower. The current environment favors a consolidation period, and time will tell if lumber continues to hold above its critical technical resistance level.
November futures fail at over $600
After falling below the $500 per 1,000 board feet level in August, lumber futures recovered but could only manage another lower high.
The chart highlights the rally that took the November contract to a $633.70 high on August 11 before it ran out of upside steam. Lumber proceeded to make another in a series of lower lows, falling to $465 on August 30. As of early September, the price is dangerously close to the critical technical support level at the August 2021 $448 low, but it has held above as of September.
Tight monetary policy weighs on wood’s price
Many market participants had hoped that two consecutive quarterly GDP declines, signaling a recession, would cause the Fed to pause on its hawkish path of increasing short-term interest rates and reducing its swollen balance sheet. However, the comments from the annual Jackson Hole, Wyoming gathering indicate that the central bank will continue to use monetary policy to combat the highest inflation in over four decades.
Rising interest rates and a strong US dollar have weighed on all commodity prices, and lumber is no exception.
At the $471 level on the November futures contract, lumber remained under pressure on September 1.
New physical lumber contracts offer hedgers an alternative, but liquidity remains challenging
Lumber futures have been trading on the Chicago Mercantile Exchange (CME) since the late 1960s. The low volume and the total number of open long and short positions (open interest) in the lumber futures arena have made liquidity problematic, scaring away potential hedgers and other market participants. The original contract called for 110,000 board feet of random-length lumber futures. The CME recently announced the delisting of random-length lumber futures and options contracts. The exchange will list new physically delivered lumber futures and options contracts, pending CFTC review. The new contracts are smaller at 27,500 board feet with a better delivery option for market participants. The CME hopes to attract a lot more volume and liquidity with the new and improved lumber futures. A full description is available via this link.
Lumber moves into the offseason for construction
As the winter approaches, new home construction tends to decline, weighing on lumber demand. There is an element of seasonality in the lumber market as it reached the $448 low in August 2021 with the fall and winter on the horizon. However, in 2022, the upcoming offseason faces rising interest rates. At the end of 2021, thirty-year fixed-rate mortgage rates were below the 3% level, and they recently were over 6%, double the level nine months ago. On a $300,000 mortgage, a 3% increase boosts monthly payments by $750 per month, which weighs on demand for existing homes and new construction that consumes lumber.
Lumber prices face an almost perfect bearish storm as we move into the fall and winter of 2022.
A recession could cause lumber to rally next spring
In 2021, the Fed and the Biden administration called rising inflation a “transitory” and pandemic-inspired event. The central bank and administration failed to take credit for the economic condition resulting from a tidal wave of monetary policy liquidity and a tsunami of government stimulus programs.
In late 2021, the Fed realized inflation was structural and committed to addressing rising prices by increasing the Fed Funds Rate and reducing its swollen balance sheet. Inflation has been a consistent talking point for the Biden administration as the mid-term elections approach. Meanwhile, two consecutive quarterly GDP declines are the hallmark of a recession. The administration has called the economic contraction a “transition,” and the Fed continues to approach inflation with a hawkish monetary policy approach. If the central bank and government in Washington DC are making the same mistake with “transition” in 2022 as they did with “transitory” in 2021, the Fed’s monetary policy tools to battle inflation are mutually exclusive for a recessionary environment. The bottom line is increasing interest rates may only exacerbate the recessionary pressures, causing a deeper contraction over the coming months and years.
As the central bank’s policies have consistently been reactive instead of proactive, they run the risk of suddenly reversing to a more dovish stance if GDP continues to decline.
The Fed continues to utter hawkish squawks, but the dovish coos could be on the horizon in late 2022 and 2023. Lumber prices will likely continue to be highly sensitive to interest rates and could provide signals for other commodity prices. Meanwhile, since high energy and food prices are supply-side issues caused by the war in Ukraine and ongoing geopolitical tensions, inflation may remain elevated despite the central bank’s attempts to push it back to the 2% target level.
Watch lumber’s price as it is a key economic indicator. The trend remains lower in early September, but wood prices will follow the economic data over the coming months. Time will tell if the CME’s new physical lumber contracts gain the critical mass that makes them appropriate for hedging and trading. Keep an eye on the volume and open interest data, which will reveal if the contracts offer more liquidity than the old contracts.
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