Commodity crunch time

 In his State of the Union address, US president Joe Biden said: “My top priority is getting inflation under control”. This will be no small task. Inflation was already ripping through developed economies as a reaction to the pandemic contraction; the war in Ukraine will only make matters worse.

Commodities are soaring all over the place: Palladium prices surged yesterday – Russia accounts for 42% of global production. Platinum less exposed, with just 12% of global output from Russia. Wheat surged, going limit up on the futures market yesterday, as did corn. Both grains are popping again this morning to reach fresh multi-year highs. 

But it’s energy prices where the real damage is being done. European gas markets have been under a lot of strain for a few months now but the impact of the Russian invasion of Ukraine, sanctions on Russia, and the risk of retaliation or stricter curbs targeting oil and gas exports, is driving global markets.  

Brent rose above $113 and WTI above $111 this morning as the market digested the full effects of the sanctions and risk of retaliation by Russia and the likely pressure that will be brought to bear on Western governments to ban Russian energy exports. Heating oil (NY Harbor futures) have also leapt to multi-year highs at $3.386. The Bloomberg Commodity Index rose to the highest since 2014 yesterday, rising by the most since March 2020. The S&P GSCI index, a similar gauge of global commodity prices, hit its highest since 2011 this morning.

The inflation impact is already there, and will get worse. Yesterday data showed Italian inflation rose to 6.2% vs the 5.5% expected. This was the highest since 1995. EZ CPI inflation today is hot, rising to a record 5.8%.

The US Markit Manufacturing PMI for February dis show that pressure on capacity softened as backlogs rose at the slowest pace in a year as material shortages eased. But while input costs increased at the slowest pace for nine months, selling prices rose at the sharpest rate since last November.

GS: “We are raising our core PCE inflation forecast to 3.7% at end-2022 (vs. 3.1% previously) and 2.4% at end-2023 (vs. 2.2%)… we now expect additional quarterly hikes next year (vs. three previously), resulting in a slightly higher terminal funds rate of 2.75-3%”. US CPI inflation hit 7.5% in January and may exceed 8% in Feb. 

Meanwhile bond yields are dropping fast. Bond yields plunged as investors seek shelter, whilst traders are drastically trimming their expectations for central banks to hike this year. Markets now price in less than 15 bps worth of rate hikes by December by the European Central Bank; last week it was 35bps by year end. US 10yr Treasuries closed at a yield of 1.725%.  

UK yields have also moved lower, signalling the Bank of England won’t be so quick to follow its last two rate hikes with another. The yield on the 10yr gilt fell 30bps to 1.11%, the biggest fall since 2009. Money markets indicate around 100bps of tightening by the BoE this year, down from about 125bps before. 

So inflation and inflation expectations are going up, whilst bond yields are dropping as investors fear for growth. This is a stagflation environment = a nightmare for central bankers. Lots for Jay Powell to ponder as he testifies later today before the House Financial Services Committee. 

Ukraine, Russia and OPEC 

Russia is starting a new phase of the campaign, bringing a lot more force to bear and shelling civilian areas. This poses the risk that the West will encounter growing pressure to sanction Russian oil and gas exports, with all that would entail. Centrica said it is urgently seeking to end its natural gas supply agreement with Gazprom – self-sanctioning already well underway. Exxon Mobil followed Shell and BP to say it will exit Russia, leaving $4bn in assets in doubt. We are seeing this with the container ships too, and banks. Moreover oil traders are already starting to try to secure alternatives. 

We should note that rising oil prices are a windfall for the Kremlin and Russia’s terms of trade – the ratio of its export to import prices – is at its highest since oil prices fell in 2014. This is one of the reasons why Western governments might play this card – the cognitive dissonance of squeezing Russia on all fronts with sanctions while still funding their war machine by buying oil and gas . The other reason will be mounting pressure from their electorates as bombing on civilians increases, leading to more deaths and distressing scenes for the TV screens.  

OPEC+ convenes later this morning and is seen maintaining the current pace of production increases, sticking to the incremental 400k bpd. The cartel’s technical experts lowered their expectations for the daily oil market surplus by 200,000 barrels to 1.1m barrels. Their estimates showed fuel stockpiles in developed nations will be some 62m barrels below the 2015 to 2019 average by the end of 2022, having previously forecast a shortfall of 20m barrels. But the market is not really moving on this as much as just pure fear of immediate disruption to supplies; traders are getting hold of barrels at any price. 

Meanwhile, the IEA said it will release 60m barrels from its reserves, with the US contributing half of the total. This has achieved nothing – clearly the market is ignoring it. It’s puny if the West does go down the route of halting Russian energy exports. Russia’s output amounts to 4-5m barrels a day, plus up to 3m bpd of refined products. 

Market moves 

Surging oil prices helped the majors on the FTSE 100; Shell +5%, BP +5% in early trade. Spiking commodity prices also lifted the miners; Rio Tinto +4.5%. 

Evraz and Polymeal rose this morning – some clearly trying to catch the knife on ‘valuations’. I’d be a lot more cautious. Both are set to leave the FTSE 100 after their market caps tumbled in recent days – both –80% YTD. No love for travel stocks yet after sharp falls yesterday. Wizz Air down another 6%, TUI down over 3% in early trade….top shareholder Mordashov sanctioned. IAG not so badly hit – business less reliant on Eastern Europe/Russia – trans-Atlantic travel is the key there. Persimmon +4% on strong trading update, higher selling prices offsetting input cost inflation. Today’s data showed house price inflation +1.7% in Feb, up from +0.8% in Jan. Rival Vistry +8% after it too reported a strong start to the year. 

US stock markets closed down in the region of 1.5-2% yesterday amid broad risk aversion. Energy outperformed. Lower bond yields might tempt some back into growth/tech, though this sector was not a standout yesterday. 

In FX, we are seeing the dollar flight we’d anticipated on Sunday night. EURUSD has taken a 1.10 handle, its weakest since May ‘20, with the dollar index trying to free itself from the resistance around 97.75, the Feb 24^th high. Gold trades higher around $1,940, Bitcoin is holding onto gains around $44k. 

Moscow’s stock exchange is still shut, Sberbank is toast and set to close all European operations, with the USD ADR traded in London at $0.00 from $15 just two weeks ago!