Perspective: Morning Commentary, 12/21/2015

Monday, December 21, 2015


December 21 – The dollar surged higher last week on the Fed’s lift-off of monetary tightening, initiated by a 25-basis point rise in its key interest rate. The greenback pulled back late-week after completing a 62% retracement of the early December collapse created when the European Central Bank extended its asset-purchasing program, rather than expanding it in accordance with the expectations that had been built. As such, a period of consolidation appears to be in order.


The question now is, where do we go from here? Is this all of the strength that we shall see from the dollar, or will it make new 12-year highs, adding fresh headwinds for the broader commodities? The Federal Reserve couched its rate hike in a dovish policy statement, but then set a target of 1.375% by the end of 2016, suggesting at least another 100-basis points of increase over the coming year. That would suggest additional strength, depending on what happens in Europe.


The ECB’s Chief Economist, Mr. Peter Praet, made dovish statements over the weekend, focusing on additional risks in emerging countries that are significant for the European economy. He also noted deflationary pressures in the manufacturing sector as a result of surplus production, along with very high unemployment. As a result, he indicated that the ECB is prepared to retain a policy favoring monetary easing as long as it is necessary. That would suggest additional weakness for the euro, which in turn would argue for more strength longer-term for the dollar.


Crude oil fell to a new low for the move of $34.12 per barrel for West Texas Intermediate early in today’s session, providing more headwinds for the broader commodity sector. Weak crude oil prices suggest to fund managers that the domestic and global economy is weak, and therefore we shall see weaker demand for commodities as a whole. Nonetheless, the grains are firm this morning, following through on late-week strength from last week.


A quick glance at the grain charts suggests that a near-term low may indeed be in place, although caution is still advised. The dynamics of the late-week rally lean more toward the technical than toward the fundamental. Fund managers had built large short positions in the grain and oilseed complex, creating added risk going into the holiday period as rainfall deficits build over the northern half of Brazil’s crop belt. The move coincided with prices having fallen either close to or actually reaching new contract lows, providing favorable timing for a short-covering rally.


Weekend rains scattered across much of Brazil, but were patchy across dry areas of Mato Grosso and surrounding areas. Additional scattered showers are expected over the next two to three days, which should be more extensive in Center-West Brazil where they are needed. Even so, the area of crop stress could expand a bit to 20% of Brazil’s belt, up from 15% last week. Expansion could be more significant if the rains falter as they frequently have in recent weeks. The soybean charts look the best in the grain complex following last week’s rally, supported by renewed leadership from the soymeal complex.


Once again, it’s important to keep current strength in perspective. South America still has sufficient production potential to add to global supply surpluses if the just-in-time rains continue across northern production areas, with above-trend yields anticipated to the south of the dry areas. However, the trade is building risk premium back into the market near-term until more is known about how the critical portion of the growing season over the next six to eight weeks plays out. It’s during that period of time when we should also get a better feel for how the demise of El Nino can be expected to shape the Midwest summer outlook for 2016.


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