Two big themes dominating markets last week were the upturn in global stock markets and the rally in commodities prices, says George Lucas, Instreet Investment’s managing director.
“Oversupply issues have plagued commodity markets of late but a bunch of recent events suggest the tide may be turning,” he said.
“The rally in commodity prices that we saw last week came off the back of geo-political events in Syria, the dropping of the oil rig count in the US, Chevron cutting oil production and Glencore significantly cutting back Zinc production. In other words, supply seems to have reached a peak.
“Whilst we caution that the path ahead for commodities may not be smooth; we do believe the turn in sentiment is near, if not already underway.”
Here’s why:
Firstly, sentiment towards commodities had become overly pessimistic and may now be bottoming out.
Secondly, there is growing evidence that sharp falls in prices have prompted the supply cuts needed for a sustained recovery. Whilst Glencore has dominated the headlines recently, it is not alone in pulling back in the mining sector. There have also been substantial cuts in investment in the oil industry.
Thirdly, when it comes to the demand side of the equation, worries about a “hard landing” in China are beginning to fade.
“In Australia, we expect low energy prices to take effect on inflation by January 2016 – which will make it harder for the RBA to hike rates.
“The weaker Aussie Dollar will also add to the risk of inflation. If the dollar doesn’t get down to 65c by December 2015, then it probably won’t get there at all, as expectations of a rate cut will diminish as inflation ticks up and China growth starts kicking in.”
A closer look at China
Spending a little more time on China, where September’s manufacturing PMIs were stable month on month, albeit still weak.
“ As a result, the equity market has stabilised too and fears that a sharp fall in equities would hit the real Chinese economy now seem overblown.”
Commentators also seem to be coming around to the belief that Chinese data should improve over the remainder of the year as more policy stimulus kicks in. Plus, whilst China’s sustainable growth rate is slowing, the impact on global demand will be somewhat offset by the fact China’s economy is now much larger.
There is a slew of data due out of China this week, which will no doubt be closely watched by the markets.
Ah, the fickleness of the Fed
Good news from China should help to counter negativity coming out of the US where confidence in the US Federal Reserve is waning.
“The Fed has lost considerable credibility over the past few weeks as it dithers on the decision to raise rates. As a result, the market no longer believes what it says.
“The market now thinks it is likely that US interest rates will be on hold until early 2016, while Fed officials still expect a rate hike by the end of the year.
“There is concern that the recent rallies – both in commodities and equities – have benefited from a very relaxed attitude toward the prospect of Fed tightening. The Fed decision to keep interest rates on hold (combined with growing expectation that the Bank of Japan will become more accommodative by the end of the month) means the market is optimistic that lose monetary policy will be with us for some time.
“The question for us – is what will it take for the Fed to make a move? They decided against a 25bp rise at their last meeting due to some market volatility and increasing uncertainty on global growth. But we’re not talking about a 100bp! If they can’t raise rates now with full employment and GDP growth of 3.9% – when can they?”
One thing the Fed needs to watch is the role of the higher US Dollar, which has been keeping a cap on inflation. But with the Fed losing credibility, the USD has been weakening which could accelerate inflation. We will learn more about US inflation this week when the latest numbers come out.
