- Joseph Barreca
What's driving markets in June 2022. Gold, oil, BoC rate hike & Record EU Inflation
Base Metals
The relief rally in copper is running out of steam. On the surface, a relief rally in industrial metals is tied to Beijing's decision to ease Covid-19 curbs, while risk appetite recovers and the broad-based dollar melts. Beneath the surface, however, pressure continues to build: our gauge of metals supply risk has collapsed, which leaves metals prices without an offset as global demand for commodities starts to slow. Our tracking of Shanghai participants' positions reveals a continued trend of substantial selling flow from China's top players in copper, which suggests domestic inventories are no longer tight as mobility and port throughput improve. And, while Covid-19 curbs are easing in China, the prospect of continued flare-ups will likely constrain the nation's ability to boost growth in the near-term. The metals complex is vulnerable to further weakening in the coming months, which fits with our view that the trading regime in base metals has morphed into a sell-rallies regime. Copper appears to be in a more precarious position than its peers given its lower energy intensity, but CTA trend followers could now add to their shorts below $9505/t. A set-up is forming for copper prices to ultimately break below the support levels which have held since early-2021.
Precious Metals
What is keeping gold bugs from capitulating? The world is chasing the same narrative: quantitative tightening is going to sap liquidity at a fast clip, while the Fed hikes into a slowing growth profile in a grand battle against inflation. And yet, consensus positioning in gold remains to the long-side, keeping precious metals prices resilient. We see evidence that the pandemic has reinvigorated discretionary trading in gold, leaving 'Other Reportables' to play a larger role in speculative markets. This group has accumulated a significant amount of
length during the pandemic, which does not appear to be correlated with inflation-sentiment or trend-following. The war in Ukraine has sent the bears packing at proprietary trading shops, but the price action has likely saved the consensus length from additional liquidations for the time being. This cohort has yet to capitulate, but without conviction that the Fed could blink, these traders represent the greatest risk for a liquidation vacuum as we exit the pandemic-regime. CTA trend follower flows additionally help to explain the stubbornly elevated positioning levels, but our simulations of 10,000 price paths suggests that prices are now challenging the threshold that would imply a sustained downtrend forming in coming months, suggesting the bar for additional liquidations from this cohort is low
Energy Markets
Brent crude prices are uncoiling above $120/bbl. The set-up was ripe for a breakout, but the EU's decision to pursue a ban on Russian crude is confirming expectations for additional supply woes. After all, our return decomposition framework has been flagging a rise in supply risk, despite signs of wobbling demand exacerbated by Chinese lockdowns. Notwithstanding, our tracking of congestion data in China's top 15 cities by vehicle registrations has been pointing to a rise in mobility for weeks, which should support transportation demand for petroleum products. In turn, the rally is also fueled by growing expectations of supply hurdles.
The OPEC+ group of producers continues to underproduce, which takes the sting out of the highly anticipated 430k bpd output hike this month. Following a decade of underinvestment, the world's spare capacity is left in the hands of a few Gulf nations. With few able to ramp up production, deal compliance has already risen to a massive 220% last month, and Russian output is likely to continue to suffer in coming months. The insurance and re-insurance of Russian cargoes will likely also become an operational bottleneck driving Russian production lower. The margin of safety for a trend reversal in energy markets is elevated. In this context, we remain long Dec23 Brent crude in anticipation of a continued rise in supply risk premia.
BoC Set for 50bp Hike
The Bank of Canada is set to raise interest rates for a third consecutive meeting today, and the Bank’s recent communication has strongly suggested we’ll see another 50bp hike. As discussed in our BoC preview, 50bp is also our base case scenario for today, given the strong economy (and an outlook helped by high commodity prices) and jobs market, as well as elevated inflation. Against such a macroeconomic backdrop, we don’t exclude a 75bp move: markets seem to attach a relatively high probability to this scenario given that 70bp are priced in ahead of today’s meeting. As we see a 50bp hike as more likely, there are some downside risks for CAD today, as markets may have to price some 10-20bp out of the CAD swap curve. That said, we think that the BoC will reiterate a very strong commitment to fighting inflation and allow markets to consolidate their bets on at least another 50bp hike in July and a terminal rate around 3.0%. Ultimately, this should put a floor under the loonie, which has been displaying some resilience against the USD rebound, and may not depreciate beyond the 1.2700-1.2750 area even if the 75bp bets have to be scaled back today.
EUR: On track for a return to 1.05
EUR/USD is re-testing the 1.0700 support this morning after a marginal recovery late yesterday proved very temporary. Indeed, the common currency is discounting the re-assessment of the European economic outlook after the EU announced a ban on Russian oil.
That news came in conjunction with evidence that inflationary pressures in the eurozone are
still not easing, as eurozone-wide CPI figures for May jumped to 8.1% while the core rate
advanced to 3.8% year-on-year. While high inflation is keeping the ECB tightening expectations supported, the euro – which is already embedding a good deal of monetary tightening – is struggling to find any solid bullish driver at the moment. In our view, this was a matter of time and we continue to target a return to the 1.0500 area in EUR/USD by the end of this month. Elsewhere in Europe, the Hungarian central bank raised its base rate by 50bp yesterday in line with market expectations, but didn't meet all expectations, including ours. Even the almost historically weak forint did not persuade the central bank to make a bolder move. We did get assurances that monetary policy tightening will continue, but at a slower pace regardless of market or economic conditions. Although the central bank tried to be as hawkish as possible in its communication, it was not enough for the market to reverse the forint's direction. The forint continues to be our least preferred currency at the moment, but on the other hand, still has the most potential to strengthen in the region. We see EUR/HUF around 390 in the short run with a possible quick move to 380 should one of the external factors (war, rule-of-law debate, etc.) show early signs of improvement, reducing the risk premium.