Lumber is a critical industrial commodity that reflects the overall economy and the demand for new housing. On February 1, in a Barchart article, I highlighted the rally in lumber futures that took the price above $500 per 1,000 board feet. In that piece, I wrote, “the most recent inflation data shows the economic condition is declining. While inflation is nowhere near the Fed’s 2% target, the potential for a recession could curb the central bank’s enthusiasm for increasing short-term rates. Lumber’s price action could tell us that rates will level off in 2023, and the demand for new homes will increase.” Meanwhile, March lumber futures peaked at $533.70 on February 1, where they ran out of upside steam. While inflation data remains below last year’s high, the most recent readings were above the market’s expectations, and lumber prices have turned lower, with the March random-length lumber contract falling below $400 per 1,000 board feet. 

The Fed is not likely to stop increasing rates

The January consumer and producer price index data and the latest minutes from the FOMC’s early February meeting set the stage for continuation interest rate hikes to push the Fed Funds Rate over the 5% level. 

From March 2022 through early February 2023, the central bank increased the short-term interest rate from a band of zero to twenty-five basis points to 4.5% to 5.0%. The latest rate hike was only 25 basis points, but the Fed took an aggressive approach to tighten credit throughout 2022:

Source: Forbes.com

The chart shows four consecutive 75-point rate hikes from June 2022 to November 2022. The U.S. central bank is committed to returning inflation to its 2% target rate, but the economic condition remains at the highest level in decades, despite the significant credit tightening. 

Meanwhile, short-term rate hikes are just one of the tools the Fed has employed. Quantitative tightening or reducing the central bank’s swollen balance sheet has put upward pressure on interest rates further along the yield curve. 

The Fed follows the personal consumption expenditures price index or PCE instead of CPI or PPI. Last Friday, the PCE data for January showed a 0.6% from the prior year, which was about economists’ expectations. The inflation data tells us the Fed will increase the short-term rate by 25 or 50 basis points at the upcoming March FOMC meeting. 

Random-length and physical lumber prices declined

Lumber is a primary requirement for new home building, and higher interest rates have caused the demand for new homes to decline. After reaching record highs in 2021 and 2022, lumber prices have plunged and returned to levels not seen since the global pandemic gripped markets across all asset classes. 

The long-term chart shows the all-time high in the lumber futures market before 2018 was the 1993 $493.50 high. In March 2021, the price exploded to a record $1,711.20 per 1,000 board feet. After correcting to $448 in August 2021, the price took off on the upside again, reaching $1,477.40 in March 2022. Lumber reached highs in the zero percent short-term interest environment. With 30-Year fixed-rate mortgages rising from below 2% in late 2021 to over 7%, new home, and lumber demand has plunged, with the nearby March 2023 random-length lumber futures below the $400 level on February 27. 

The new smaller, more flexible physical lumber futures contract that began trading in August 2022 fell below the $500 per 1,000 board feet level. 

Expect volatility to continue as liquidity is an issue

Lumber is a critical industrial commodity, but the futures market has yet to gain the critical mass that create liquidity. Volume and open interest are crucial as they create the conditions where hedgers can use the market to lock in and protect prices, and speculators and other market participants can trade without fear of disappearing bids or offers. As of February 27, the open interest in the active month May random-length lumber futures was 1,547 contracts. The CME introduced the physical contract to attract more open interest and volume, but the metric in the May physical lumber futures was only 703 contracts.

Until liquidity increases, price variance will remain high, with the price vacuuming up or down without any trading volume during rallies and downside corrections. 

The national debt issue could be bullish for lumber prices

One of the issues facing lumber and markets across all asset classes is the impending debt ceiling crisis. The U.S. national debt is now over $31.5 trillion, and when the Fed pushes the Fed Funds rate to 5%, it will cost an incredible $1.575 trillion to service the debt annually. Even if the government can control expenditures and balance them with tax revenues, the national debt will rise because of higher interest rates. 

Meanwhile, the slim Republican majority in Congress is insisting on austerity concessions to agree to raise the debt ceiling, and the administration has said it is not willing to negotiate. A default on the debt could be a watershed event, causing confidence in the U.S. to erode and interest rates to spike even higher. As credit declines, the cost of borrowing rises. The lumber market is now sitting and waiting to see if rate hikes level off or if a default will cause a period of extreme volatility and hardship. 

Levels to watch in the random-length and physical May contracts-Watch lumber; don’t trade it until it has critical mass

The new physical contract has little price history, so the technical support and resistance levels are at the May contracts’ highs and lows of $712 and $400 per 1,000 board feet. 

The random-length futures chart shows the first support level at the January 2023 $338 low. Below there, the March 2020 $251.50 low is the long-term technical support level. On the upside, resistance stands at $533.70 and $682.60 per 1,000 board feet. Above there, wild volatility, as we witnessed in 2021 and 2022, is likely. 

Interest rates are critical for lumber prices. In February 2023, the trend in rates is higher, putting pressure on lumber as we head into the spring construction season, with mortgage rates at the highest level in many years. 

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