The big market theme of the week has been the dramatic rise in interest rates. The trade is expecting an end to the Bank of Japan’s quantitative easing, and tightening by the European Central Bank. In addition, the chatter from the Federal Reserve is that they believe the US economy is strong that further rate hikes may be needed. This is a change from the sentiment at the end of last year, when traders thought the tightening had about run its course. We’re also focusing on Friday’s payroll report for February, which is expected to show relatively strong payroll growth (around 210,000 new jobs expected).
This big jump in rates has had a large ripple effect across many markets. Higher rates have turned stocks lower, caused a large rally in the Dollar, and have hurt precious metals. This sudden market turnaround has set up Friday’s payroll number as a potential tipping point for the near term direction of Fed policy.
S&Ps: The double top around 1300 in the S&Ps brought on a big wave of short selling. 1278 is Fibonacci retracement support, and failure to regain 1278 to 1280 should keep the pressure on. Downside objectives would be 1270, and then potentially the February lows under 1260. A rising interest rate environment threatens corporate profits and consumer spending.
Treasuries: With expectations for rates moving from one at the beginning of the year to the current expectation of three to four hikes in 2006, Treasuries have taken it on the chin this past week. The yield on the 10 year rose over 4.75, the highest level since June 2004. The big tail left by Tuesday’s recovery may help stabilize trade for a bit, but with the expectations for higher US interest rates, look for lower prices.
Dollar: Monday night St. Louis Fed President William Poole warned that the U.S. economy still has a "great deal of momentum" and that the Fed may have to "step a little harder on the brake" if economic data continue to bring positive surprises. Interest rate differentials drive the foreign exchange market; the idea that US monetary policy will remain tight blunted the impact of last week’s rate hike by the ECB.
EuroFX: The euro has fallen nearly 200 points since the ECB rate hike. With the strength in the Dollar, look for the Euro to retest the 2006 low around 11850, barring any negative US economic surprises. A weak US payrolls number on Friday could help stabilize prices around 11950, but I’m expecting lower prices.
Yen: The likelihood of higher Japanese interest rates failed to support the Yen, and a slide back toward February lows around 8550 is likely. However, the prospect of tighter policy by the Bank of Japan should help support the Yen around these consolidation lows.
Canadian Dollar: The Canadian Dollar is showing its correlation to commodity prices, as the big decline in metals and energy prices hammered the Canadian in spite of a Bank of Canada rate hike. The market is trading in the old congestion area in the mid 8700s, but it’s likely that the Canadian will head toward the mid-February lows around 8650.
Gold: The narrow range day setup on Friday led to Monday’s big washout. Hawkish Fed rhetoric and a lowering of tensions with Iran led to a sharp selloff. Tuesday’s trade saw a successful test of critical $550 support, which may lead to some stabilization, but only regaining $560 takes the heat off.
Silver: Though silver followed gold down on Monday, it was able to stabilize around $10.00. Expect a retest of recent highs around 10.20, but I’m starting to wonder whether the industrial metals are beginning to prove the old adage that “the only cure for high prices is high prices”.
Copper: Copper is one of the main reasons I’m beginning to suspect that the run in silver may be coming to an end. Last week saw the third push up toward 230, and the big failure seen since then may be finally ending copper’s big run. The weekly charts have turned negative, and a drop below double bottom support around 212 should seal it for the bulls.
Cocoa: The ongoing supply deficit and impending end to the Ivory Coast harvest are providing support for May Cocoa around 1450, and this stabilization may prove to be the catalyst for a rally, which could be confirmed by a move over last week’s high at 1475. The large spec and fund long position remains a worry.
Sugar: Recent energy price weakness and the upcoming Brazilian cane harvest are keeping sugar bulls nervous. Look to buy a break back toward 1650 basis May, as stabilizing energy prices would revive sugar.
Energies: The potential defusing of the Iranian nuclear situation and expectation of a rollover of OPEC production levels are weighing on energy prices. I believe we could see a major resurgence in price this summer. The extremely warm winter blunted heating oil demand this winter, but nothing has been done that would ease gasoline demand when summer driving season comes.
Gasoline stocks are running above their longer term average, but still remain under the 2005 level. In addition, US refining capacity remains tight, and it is estimated that approximately 20% of US Gulf refining operations remain offline, contributing to supply tightness.
Although it’s early in the season to expect a major rally, traders should look for a drop into the lower $1.60 area basis June as an opportunity to position for the summer driving season rally, with the January highs around $2.00 as an objective.
Corn: The corn market may be poised for more upside as the diversification of corn from an animal feed to an industrial product is increasing corn’s demand base. World ending stocks are at the low end of the recent range, and the world stocks to usage ratio is at its second tightest level in history.
There are some big “ifs” for corn prices for the upcoming season. The first potentially negative factor for corn is the possible spread of avian flu. Given that poultry feed is a primary consumption source for corn, the spread of avian flu could blunt the traditional demand base.
As much of the new demand has been corn’s use as ethanol production, corn price will be correlated to energy prices, although with the capital costs of ethanol plants, much of the ethanol production is relatively price inelastic.
The third factor, and biggest wildcard, is 2006 US production. Recent years have seen big production and high yields, and any decrease in US yield could have a big impact on price this summer, given the tight supply and strong demand situation.
In the short term, we might expect to see some downward pressure on prices as we move toward planting. I would view a break back toward 250 basis December as a good opportunity for a summer play in corn.
The information in this article includes information from sources believed to be reliable and accurate, but no guarantee is made as to accuracy, nor do they purport to be complete. Opinions are subject to change without notice. Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.