Commodities Drop As FOMC Deflates the Reflation Trade: Ole Hansen, Saxo

The grains market suffered its biggest one-day drop on Thursday since 2009 as expectations of crop-friendly weather in parts of the US Midwest and production upgrades from producers around the world helped sour the sentiment across the most short-cycled commodity sector. By that we mean the agriculture sector’s ability – weather permitting – to correct its supply outlook from tight to ample from one season to the next.

Soybean futures, already reeling from the prospect for lower biofuel demand from US refiners, suffered one of the largest daily losses ever. Corn meanwhile was down more than 12% on the week before news of a five-fold increase in China’s May corn imports helped support calmer price action into the weekend.

We are currently in a very weather-driven market, and just like we are currently seeing softer fundamental in metals, internal fundamentals such as the improved crop outlook does not justify a correction on this scale. Instead, the focus turns to financial investors many of which have been caught off-side by the sudden change signaled by the Federal Reserve on rates and inflation. Once the dust settles following this bout of long liquidation, all it may take to reverse the market higher will be another change in the short-term weather outlook.

Crude: While pockets of weakness before the FOMC meeting had started to emerge across the metal and agriculture sectors, crude oil increasingly looked like the winner being supported by the combination of rising demand and OPEC+ keeping supplies tight. However, the derailing of bullish commodity bets after the FOMC meeting also managed to trigger some relatively light selling in crude oil.

Up until then, speculators remained strong buyers in the belief downside risks were limited with OPEC+ keeping supplies tight at a time of rising demand. A demand growth that, according to the IEA, could rise to post pandemic levels late next year. Another weekly drop in US crude oil stocks failed to add further price strength with stocks of gasoline and diesel rising at same time.

Post-FOMC weakness aside, the price found support in forecasts from the world’s top commodity traders, all speaking at the FT’s Global Commodity Summit, that oil prices could return to $100 over the coming years as investment in new supplies slows down with oil majors diverting capex towards renewables instead of continued oil and gas production. It highlights a potential rising dilemma where politicians and investors want to move towards renewables at a much faster pace than actual changes can be made. Thereby creating the risk of a supply shortfall before demand eventually begins to slow towards the second half of this decade.

What is clear, however, is that OPEC+ remains firmly in control while global demand continues to recover. At least until a time when non-OPEC+ producers react to increased revenues and profitability by boosting output. Actions with regard to production levels being decided at their early July meeting will be important in so far as it will send a clear signal whether the group, led by Saudi Arabia, seeks higher prices by keeping supply artificial tight or whether it prioritizes stability through increased production.

Source: https://www.home.saxo/content/articles/commodities/wcu-commodities-drop-as-fomc-deflates-the-reflation-trade-18062021