Wednesday, December 17, 2014

Why are all commodity prices falling, everywhere? | Yellen: “A couple means two”

Commodity prices seem to be falling just about everywhere, and in all classes. The virtual collapse of oil is well publicised. Those with an interest in Forex, as we are, will be well aware of the effect that rapidly declining Iron Ore prices are having on the Australian dollar, in particular. The softer commodities, too, for example beef and dry powdered milk, are also causing problems for producers of the raw materials that go into them.

The reasons for all of this amounts to something of a perfect storm for suppliers. Slowing demand, particularly from China, is a significant factor. New Zealand milk producers were among the first to experience this, and their problem has been exacerbated by new entrants into the supply chain, coming both from their near neighbours in Australia and from as far afield as Ireland, all encouraged by apparent buoyant demand which started to disappear just as the they had geared up to provide product.

The supply side is also a major factor in oil price decline. Shale oil production in the USA has not only helped the US economy, but has also caused the traditional oil nation suppliers to have to rely on other markets to dispose of the crude that shale has displaced. So in many instances, supply has reached an increased level at the very time when demand has softened. Prices will always fall in such circumstances.

But there is also a macroeconomic dimension. A great many of the world’s commodities are priced in US dollars, both for physical product and for the futures contracts that are used by buyers and sellers to hedge their risk, and by traders for speculative purposes. Whatever about the outcome of the latest FOMC meeting, Quantitative Easing has come to an end, which means the end of easy money (US dollars) and a rise in US interest rates. The history of core interest rates in the US indicates that when they go up, the US dollar strengthens and commodity prices fall. The only difference this time around is that, at the same time that US rates are about to rise, the supply and demand dynamic has also become critical. Hence the idea of a perfect storm.

Outside of the USA, there has to be comfort in the thought that low prices for commodities, for all that they feed into the deflationary tendencies that are so feared by central bankers, will also place more spending power in the pockets of consumers, and thereby hasten the day when the economic upturn that the US seems to be embarking on will spread to the rest of the world.

Yellen: “A couple means two”

The FOMC press conference after the monetary policy statement last evening (GMT) was an assured affair. The Chair of the Federal Reserve, Janet Yellen, was meticulous in her comments and in her answers to questions from assembled journalists. She handled the whole thing herself - there were no acolytes in attendance, unlike in the case of both her ECB and Bank of England counterparts at similar events.

The major currency pairs that involve the US dollar jumped about a bit after the statement and during Ms Yellen’s comments (we were out of the market for the duration), but then settled into a strengthening bias as far as the Greenback was concerned. And well they might. The clear message was “Steady as she goes”. The recovery in the US is well under way. The committee is not concerned either about low inflation, nor falling oil prices. They still see some slack in the economy, but labour force participation rates are on the right track, as are employment trends.

In the current FOMC scenario, interest rates will begin to rise when a “couple” more FOMC meetings have taken place. Ms. Yellen very helpfully confirmed, for an enquiring journalist, that she subscribed to the dictionary definition of a “couple”, as meaning two. The FOMC meeting schedule for 2015 is above. As can be seen, each alternate gathering is concerned with a Summary of Economic Projections and is followed by a press conference. She was at pains to point out that interest rate rises could take place without a press conference, but the clear expectation of all now is that the middle of 2015 will see the US embarking on a normalisation of monetary policy, i. e. a gradual rise in core interest rates.

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