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The U.S. economic outlook continued to deteriorate into the middle of August, with fears of a double dip recession growing almost daily. The Federal Reserve apparently isn’t concerned though, as they have not rushed to the rescue with additional easing efforts beyond the Federal Reserve’s Open Market Committee announcement on August 10th that they would use proceeds from maturing mortgage debt to buy Treasuries. With recent CPI readings depicting a greater chance of deflation rather than inflation, it wasn’t surprising to see a number of U.S. Treasury yields reach fresh, historically low levels. In retrospect, the September Treasury market has managed a very surprising 8-point rally from the late July lows, where previously it appeared that the Treasury market was poised to roll over to the downside! However, news that China has reduced their holdings of U.S. Treasuries for the second month in a row coupled with increased vulnerability in the Dollar may reduce the attractiveness of U.S. Government securities.
The monthly U.S. payroll report was disappointing and U.S. manufacturing readings have been soft, making it difficult to turn the upward trending Treasury market around. U.S. 2nd Quarter Productivity showed the first decline in six quarters with results that were below expectations. June Wholesale Inventories and Sales figures both came in below expectations and served to add to the already fragile sentiment. Foreclosures in July jumped to nearly 93,000 units, up 9% from June and up 6% from a year ago.
With the recent appreciation of grain prices sparking global inflationary fears, the falling Dollar and the potential for reduced interest from China, one of the most important holders of U.S. debt, we suspect that U.S. Treasuries are beginning to look really expensive. A very significant top might be in the offing over the coming month.
The threat of a continued longer-term downtrend in the US dollar might provide some temporary support to the commodity market sector, but it will be more important to see an expanding global economy for commodity markets move higher. If the sluggishness of the US and European economies spreads to China and other emerging markets, recessionary demand will return to the commodity markets.
Fund traders hold aggressive net long positions in many agricultural markets, so a shift in psychology should not be taken lightly. A number of factors could leave fund traders in a position to “throw-in-the-towel” on the long side of the commodities play. A few concerns which come to mind include:
- China’s demand slows if their housing market bubble bursts.
- India begins to export cotton, wheat, rice and sugar on the world market, which may dispel some beliefs that world supplies are extremely tight.
- Energy supply continues to swell.
- New regulations aimed at speculators have unintended consequences.
There are certainly plenty of factors that could spark sharply higher commodity prices, including weather, but we see many commodities in general as being too overbought given their supply outlooks. It will take strong global demand growth in just to rationalize their current price levels. We would caution traders to consider buying only in markets with supportive big picture fundamentals.
