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Commodities prices may struggle to recover till substantial correction in dollar

The biggest reason behind weakness across commodities is the persistent strength in the US dollar. The US dollar index has gained more than four percent since the start of the year and tested the highest level since 2002.

July 16, 2022 / 07:57 AM IST

Ravindra Rao, VP - Head Commodity Research at Kotak Securities

Commodities have been falling for quite some time now and we have seen little respite yet as the US dollar has continued to head northwards while demand concerns have intensified. The recent trend shows that commodities are largely hinged on the trend in the US dollar and we may not see much improvement unless there is a substantial correction in the currency.

Last week, we saw a sell-off across commodities and most hit fresh lows. Gold slumped to a 11 month low while silver slipped to July 2020 lows amid persistent strength in the US dollar. Industrial metals also plunged on growth worries, China's virus concerns and weaker risk sentiment with copper hitting November 2020 lows. Crude oil also came under pressure and tested the lowest level since February 2022.

Growth concerns and monetary tightening expectations weighed on equity market as well, but most benchmark indices held above recent lows. The US Dow Jones Industrial Average index is set to end the week lower but is still well above the lows hit in mid-June. The only major outlier is the Chinese equity market. Shanghai equity index has slipped to a one month low. The relatively smaller fall in equities shows that market players are waiting for fresh triggers.

The biggest reason behind weakness across commodities is the persistent strength in the US dollar. The US dollar index has gained more than four percent since the start of the year and tested the highest level since 2002.

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The US dollar index has been the biggest benefactor of weaker risk sentiment as market players have shun equities and commodities and moved to the safety of the US currency. US Treasury bonds have also seen some buying interest but other safe havens like gold, Japanese yen and Swiss franc are yet to attract investors.

The latest leg of rally in US dollar is triggered by US inflation data as it had fuelled debate if the US Fed may further increase the pace of rate hikes to get inflation under control.

US consumer price rose 9.1 percent on the year in June, the fastest pace in 40 years, beating market expectations of 8.8 percent growth. Adding to it, US producer price rose 11.3 percent on the year in June as against forecast of 10.7 percent growth. The inflation data shows that there are little signs of inflation peaking yet.

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Fed started the monetary tightening cycle in March and has already raised the pace of rate hikes from 0.25 percent in March to 0.5 percent in May to 0.75 percent in June. With inflation still out of control, market players are now assessing the possibility of a bigger and unprecedented one percent hike. Fed wants to get inflation under control and is ready to take all possible measures so another major hike can't be ruled out.

However, we believe that the central bank needs to take into account the weakening outlook for the economy. The inversion of parts of the bond yield curve highlights increasing concerns about the health of the economy.

Fed's next meeting is on July 26-27 and until then market players may continue to look at US economic numbers and central bank comments to gauge the central bank's next move. We may see some volatility in the US dollar also as market players assess the monetary policy stance of other central banks.

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Bank of Japan and European Central Bank (ECB) are due to hold their monetary policy meetings in the coming week. Bank of Japan is expected to maintain its support for loose monetary policy stance. ECB is expected to start its rate hike cycle and this has been factored in and we may see more reaction to the pace of monetary tightening.

The euro has already slipped to parity with the US dollar for the first time since 2002, and we may not see much recovery unless ECB takes an aggressive monetary tightening stance. Unless we see a substantial correction in the US dollar, commodities may struggle to recover.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Ravindra Rao is the Head - Commodity Research at Kotak Securities.
first published: Jul 16, 2022 07:57 am
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