Financial Markets Looking at Commodity Prices

The price moves are not for the most part very big, but it is beginning to look as if the markets are rolling over. The dollar, yen and Swiss francs are all relatively strong. Equity markets are under pressure. The MSCI Asia Pacific Index and the Emerging Equity Index are off 1.3%-1.5%. Europe bourses are also in the red, with the Dow Jones Stoxx 600 off almost 1%. Core bond yields are lower and the periphery higher.

There is much focus at the moment on the decline of copper, iron ore and crude oil prices. Copper prices continue to plunge. The 5% limit was hit in Shanghai. The four-session (though today) swoon, copper prices have fallen nearly 10%. The break of the $300 level is important as that represents the shelf that extends back to 2011.

The decline in copper prices is understood largely as an indicator of the financial squeeze in China and the use of copper as collateral. Last week was the first on shore corporate bond default in recent years, and this has been followed increased attention to news that a utility company was delisted in China and that the Jilin Province Trust Co has now missed its sixth interest payment. The product, like many in the wealth management space was to finance mining projects. The decline in iron ore prices may be both cause and effect of the financial squeeze.

The yuan fell to new lows for the week. The PBOC's efforts to get the private sector to reduce the excesses is paying off. This is seen not just in the commodity prices, but also in the yuan non-deliverable forward market. It is a reflection of speculative sentiment. The 12-month forward fell to six-month lows today, nearly 1% discount to CNY.

The CRB Index appears to be topping. It had rallied 13.5% from the January 9 low to Monday's high. Yesterday's price action warns investors with broad commodity exposure of increased risks of a downside, and possibly sharp correction is likely. There are knock-on implications for currencies that are perceived to be linked to commodities and companies in the space.

Among the majors, the Australian dollar appears to be most sensitive. With today's decline, the Aussie has extended its four-day decline to about 2.4%. Support now is pegged just below $0.8900 after testing the $0.9130 area at the end of last week. Australia reports employment data early tomorrow. A 15k increase in employment is expected, but market expectations have proved too high in recent months.

In contrast to Australia, the central bank of New Zealand is expected to raise interest rates 25 bp tomorrow to 2.75%. It is expected to be upbeat and support the aggressive tightening the market has discounted with 25 bp hikes in April and June. The failure to affirm these market expectations could spur a sharp correction, with risk to $0.8380-$0.8400.

The Japanese economy appears to be accelerating this quarter after a lackluster H2 13 with 0.2% expansion in both quarters. The Tertiary Industry Index rose 0.9% in January, half again as high the expectations following a 0.5% decline in December (initially -0.4%). However, price pressures do appear to have peaked as BOJ Governor Kuroda previously indicated was going to happen. The domestic corporate price index fell 0.2% in February rather than the 0.2% increase that economists had expected.

The main news from the euro area, besides the chin wagging about the still lack of agreement on the banking union, is the disappointing industrial production report. The 0.2% decline in January compares with a consensus forecast of a 0.5% increase. It is the second consecutive decline and the fourth in five months, underscoring Draghi's characterization of the economic recovery as, "weak, fragile and uneven."

The euro itself remains resilient. Since breaking above the $1.38 nemesis last week, lifted by the ECB lack of action and extending to $1.3915 before the weekend, the euro has been consolidating. Today it is within yesterday's ranges. We do suspect the euro is carving out a near-term top, but its resilience warns of upside risk.

We did not see much new in the BOE's comments before the Treasury Select Committee yesterday. Short-sterling futures were little changed. Sterling has been heavier than the euro, but it is finding support just above the ~$1.6585 low from February 24, which is the neckline of a potential double top. A break of this area would indicate that the consolidation is evolving into an outright correction.

It is another session devoid of data or speeches in the US and Canada. There is likely to continue to be more focus on the commodity markets than is usually the case. In addition to copper prices, the North American market will also be watching oil prices. The front month May crude oil contract is extending losses through the $100 a barrel level, extending the loss to 6.4% this month. A break of $98.35 would suggest a technical target near $96.70.