Perspective: Morning Commentary for May 8

May 8 – Stock futures had a weaker tone this morning as commodity prices turned lower as well on mixed global economic signals. Wall Street is disappointed that the economic news has been good enough to prevent the Federal Reserve from cutting rates, but traders are also realizing that the economy is doing fine thus far without the rate cuts. The VIX is trading near 13 again this morning, while the dollar is trading near 105.6 as the Fed remains the more hawkish of the major central banks. Yields on 10-year Treasuries are trading near 4.49%, while yields on 2-year Treasuries are trading near 4.84%. Crude oil prices are more than 1% lower on rising stocks, having set fresh eight-week lows this morning, while the grain and oilseed markets were again under modest pressure overnight as traders position for one of the larger USDA WASDE crop reports of the year on Friday.

Upward pressure on the dollar continues as the U.S. Federal Reserve plays the role of the most hawkish central bank in the world. But that’s also creating a bit of a currency war currently, as other countries try to defend their currencies. Several other central banks are interested in cutting interest rates to stimulate their economies, but they’re worried that doing so will simply add to their own currency woes. Among those indicating concern is China. It’s economy has been struggling for some time – especially its property sector that is so key to its economic health. The yuan has been hovering at some of its weakest levels versus the dollar of the past 15 years at a time when China desperately wants the world to see the yuan as a strong alternative to the dollar.

China believes that the United States reached economic superiority in the world by having the world’s common currency after World War II. It wants to take that position from the United States, so therefore it desires to see the yuan eventually reach the point of being the world’s central currency. It can’t make progress toward that end if the yuan is seen as weak and volatile. An official of China’s central bank stated in January that China should have more room for stimulus this year as the United States starts to cut rates, but those rate cuts have not materialized, leaving the yuan to drift. As such, China appears to be quietly taking action to support the yuan while withholding significant stimulus. China’s foreign exchange reserves fell by $44.8 billion in April as China dipped into those reserves to defend the yuan. That still leaves its foreign reserves at more than $3.2 trillion, so it still has plenty of room to support the yuan. A global currency must be seen as one that is allowed to float in the global market, driven by its fundamentals, so intervening to support one’s currency also works against its objective of the yuan being seen as a strong alternative to the dollar. South Korea’s foreign exchange reserves dropped by their largest amount in 19 months as it seeks to support its currency, while other countries take action to sell the dollar as well. However, those other currencies aren’t seeking to displace the dollar as the accepted global currency. This does though explain some of the times when the dollar seemed to have a lid on it, preventing it from going higher.

More negative economic data was released in China raising concerns about its well-being. China’s warehouse index fell to 49% in April, down from 52.6% in March and the lowest since January 2023. The subindex for new orders dropped 4.9 points to 48.2%, with the profit subindex dropping 5.1 points to 49.1%, while the turnover index fell 6.7 points to 49.1%. These data points indicate why the government started emphasizing its “old for new” campaign seeking to boost consumer demand by encouraging people to replace older items. The warehouse index raises fears that we will see even greater deflationary pressures in the second half of this year for China’s economy.

Wall Street fretted over the U.S. yield curve inverting in mid-2022, with traders saying that it is a predictor of a recession yet to come. Fund managers carried that theme over into the commodity sector at that point, shorting the market in a “commodity deflation” theme on expectations that rising interest rates would send us into a recession that would decrease demand for commodities. That didn’t mean that I was bullish the commodities as much as I believed, based on history, that the market would manage supply and demand at higher price levels than when it was worried about recession. The recession never came, and the economy remained resilient. As such, we started projecting an end to the commodity deflation theme six months ago, suggesting that it would come in the second or third quarter of this year. Geopolitical risks had already pushed the shorts out of the energy sector, while fund managers continued to hold massive short positions in the grain and oilseeds through the first quarter of the year. The change in market psychology simply makes it easier for the market to respond to supportive fundamental stories, and we’ve seen that play out in recent weeks, with reports of cold and drought in Russia, disease problems in Argentina’s corn crop and excessive rains in southern Brazil. None of these stories yet provide sufficient evidence to justify rationing U.S. demand with higher prices, leaving prices vulnerable to setbacks similar to what we’ve seen in the energy space. But they do reflect a different atmosphere in the commodity space as the dynamics change.