There’s no doubt that the Federal Reserve has been in the driver’s seat of the economy for years now. The days of QE may be over, but the Fed still holds the reigns with its current interest rate policy. The fact that rising rates aren’t moving at all as most investors expected since the first hike began means that any action or statement by the Fed is regarded as major news.
There’s a casualty to the Fed’s inconsistent policies though: commodities. The year began with a lot of optimism for commodity values, but those hopes have been long since dashed. The Bloomberg Commodity Index showed gains for the first two quarters this year, but appears to be declining for the third – and most likely fourth – quarter. While the fall in oil can largely be blamed on OPEC not cutting production and the war against falling market share, other commodities are suffering at the hands of the Fed.
Commodities are Flying Blind
Commodity-based ETFs have seen money outflows of $791 million over the past month, and investor interest is falling quickly. While factors like decreased demand stemming from China and oversupply issues can be partially to blame, the Fed’s constant threat of an interest rate hike is scaring potential investors away.
Investors predict a 48% chance that the Fed will raise rates before the end of the year, and higher interest rates equal lower commodity prices. A rate increase is good news for the US dollar, which will soar, and that means a relative drop in commodity prices (that are priced in USD).
There’s an argument to be made that just the threat of higher rates is doing as much damage as an actual hike by discouraging investment. Once a rate hike happens, it’s possible commodities may rebound slightly once the constant threat of the falling ax is removed. However, if the Fed continues its hawkish views, commodities will suffer.
If interest rates aren’t enough of a weapon, the Fed is now pushing for a repeal of permission that was given, in 1999, for Goldman Sachs and Morgan Stanley to store and transport physical commodities – something their competitors aren’t able to do. Concerns regarding banking activities in commodities were raised citing possible risk to safe financial markets. Disallowing these banks to deal in commodities could be yet another blow to commodity prices, and further reduce investor activity in the markets.
As long as the Fed keeps stringing investors along with a mix of hawking and dovish policy statements, commodities face a battle they can’t win without some extraordinary macroeconomic support. Support that isn’t likely to happen anytime soon. But oil may be the one commodity to stand out, since its low price is due to OPEC’s actions rather than the Fed’s. Oil is already beginning to rise and that trend could continue, albeit at a mild pace, for the rest of the year.