Commodities at large along with other asset classes have been in disarray ever since the Fed projected the possibility of early rate hikes. We have seen market players reacting to every economic number and central bank comment to gauge how soon the Fed can act. While market reaction has subsided, we are set for volatile times as we move towards another Fed meeting next week.
Fed officials at their last meeting projected the possibility of two rate hikes by 2023 and also began discussion to taper asset purchases. Since then, Fed officials have largely painted a mixed view on the need for monetary tightening. However, Fed Chairman Jerome Powell has repeatedly maintained a dovish stance and played down inflation risks.
US economic numbers have also been mixed highlighting uneven recovery. Consumer price in June rose at the fastest pace since 2008 amid further signs of rising inflation concerns. Labour and housing data has been mixed while manufacturing activity has paused.
On the global front, virus risks have intensified as increasing cases of Delta variant are being reported in the US and Europe while a number of other countries have tightened restrictions to deal with the spread.
On the central bank front, major central banks like ECB, Bank of Japan and Bank of England have largely maintained an accommodative stance despite seeing rising virus cases.
The general outlook for the US economy still remains positive however uneven domestic recovery, persisting challenges from virus spread and loose monetary policy stance of other central banks may result in Fed taking a more measured approach.
If we look at financial markets, the general strength in the equity market and commodities at large indicates that market players are not too worried about the Fed starting monetary tightening soon. However, if we look at the US bond yield curve, it has flattened indicating the possibility that rate hike may happen soon. Since the Fed's last meeting in mid-June, the 2-year bond yield have inched up while 10-year yield has corrected substantially, narrowing the gap between the two. The US dollar index has also hit April highs reflecting diverging outlook for monetary policy of Fed and other central banks.
Commodities witnessed a sharp slump in the last few days on virus concerns, signs of slowdown in China and volatility in crude oil price. However, we have seen some stability amid general strength in equity markets which reflects growth optimism. We may see continuation of recent gains if the Fed sounds more dovish, however if the US central bank shows further inclination towards monetary tightening soon, commodities may come under pressure.
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