Commodities traders may shift focus to China's industrial production & retail sales, US inflation

Ravindra Rao, VP - Head Commodity Research at Kotak Securities

Commodities showed some signs of recovery this week as the US dollar index struggled to build on its gains. The US dollar has continued to be the key price determining factor for commodities and this trend may continue as market players position for US inflation data next week and the US Federal Reserve’s monetary policy decision later this month.

Gold slipped below $1,700 per troy ounce but managed to bounce back as the US dollar lost momentum. Industrial metals also found some footing as risk appetite improved. Crude oil, however, struggled with demand concerns and tested the lowest level since January.

The US dollar index saw a good start to the week and tested a fresh 2022 high on the back of the Fed’s hawkish stance and as safe haven buying. A spate of Fed officials, including Chairman Jerome Powell, expressed support for aggressive moves to control inflation, a step which further cemented market expectations of another sharp rate hike at the upcoming meeting.

The Fed’s tightening expectations were also unaffected by a mixed US jobs report. The US dollar rose also on safe-haven buying, as the outlook for the European economies was clouded due to the worsening energy crunch while China struggled with the virus spread.

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The US dollar index, however, corrected from the highs as stability in equities reduced its safe haven appeal and as market players assessed the Fed’s monetary policy against other central banks.

Equity markets found some footing this week reflecting improved appetite for riskier assets. Growth concerns, monetary tightening expectations, China's virus spread and Europe’s energy crisis continued to weigh on market sentiment. Risk appetite however, improved on some upbeat economic readings and easing inflation concerns. Market players also managed to react positively to monetary tightening by major central banks.

The US weekly jobless numbers fell to a three-month low reflecting strength in the labour market. Inflation concerns eased somewhat amid sharp correction in energy prices and commodities at large. European gas prices slipped to a one-month low this week as EU authorities worked on ways to control gas and power prices, and reduce consumption. Crude oil slipped to January lows amid demand concerns. China’s inflation data also showed easing price pressure.

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One of the biggest factors behind the rise of the US dollar has been the Fed’s aggressive monetary tightening stance. The US currency lost momentum as other central banks have also stepped up efforts to control inflation. The European Central Bank (ECB), at its meeting this week, raised the key lending rate by 0.75 percent and kept the option open for additional moves.

ECB’s move was largely anticipated following hawkish comments last week and rise in Euro-zone inflation to a fresh record high level. Amid other central banks, Australia and Canada also raised interest rates this week to control rising prices.

The US dollar succumbed to profit taking also on expectations that authorities may take measures to support their currencies. A number of Japanese officials have expressed their concerns about the Japanese Yen’s rapid fall and indicated their willingness to act. South Korea has also expressed concerns about increasing uncertainty in the currency market. China recently cut the forex reserve requirement rate by 2 percent to support the yuan.

While commodities have recovered, there are numerous challenges that could derail a sustained recovery. The US dollar’s sharp rise has made it vulnerable to profit-taking. However, with the Fed’s continuing emphasis on aggressive rate hikes, a sharp correction is difficult. European gas prices have corrected easing inflation concerns and improving the outlook for Europe. However, supply risks relating to Russia may continue to support prices.

Outlook for China may also remain weak unless it manages to get the spread of the virus under control.

Amid persisting challenges, market players may now shift focus to US inflation data and China's industrial production and retail sales data. Also in focus will be China’s virus situation and measures by the European Union to control energy prices.

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