- Commodity prices have declined sharply on over-supply and worries about China’s outlook
- Price correction looks exaggerated and stronger growth should set scene for a recovery over time
- Commodity prices will limit headline inflation in coming months, but Fed still likely to hike
Brent oil tests January lows on global glut concerns
Brent oil prices dropped towards the January lows after the release of the US inventory data. US crude inventories rose, adding to investor worries about the global oil glut. WTI has already traded at a 2015 low for several days. The worries came on top of the already negative market sentiment regarding commodities in general, including oil. Many commodities are confronted with oversupply. This can be partly the result of many years with high prices, which gave an extra impulse to production. But another part is the result of disappointing demand, and in the case of China, increased worries regarding future demand. This combination has led to heavy pressure on cyclical commodities.
Normalisation of sentiment should be positive for commodities
We think that the downward correction in commodity prices has gone too far. Oil prices below USD 40/barrel are not sustainable as this would lead to a further sharp cutback in investments. Also the worries regarding future Chinese demand for base metals are over exaggerated. Despite some near term downside risk due to the extremely negative market sentiment, we expect a technical upward correction as soon as investors realise that they have pushed commodity prices down too far, too fast.
We think that oil prices could regain some of their losses as soon as the markets start to anticipate a better balance between supply and demand. However, this will most likely not be seen before US crude production is finally significantly hit by the low oil prices. We therefore expect oil prices to remain low for longer (Brent average USD 60/bbl and WTI USD 55/bbl in 2015). Cyclical base metal prices – like copper, zinc and nickel – should be able to recover as soon as future Chinese demand worries ease. Our base scenario remains for a soft landing in the Chinese economy, as stimulus feeds through to support economic growth.
Commodity price declines point to a lower outlook for headline inflation, but Fed will still likely hike
Lower commodity prices – especially oil – point to a lower profile for headline consumer price inflation in the coming months around the world. Annual inflation will still likely bounce at around the turn of next year, but the rise will be more muted than previously expected. Global manufactured goods prices are also weak, where as in the US, dollar strength is also currently capping goods price inflation.
Having said that, central bankers generally tend to see the impact of commodity prices as being relatively transitory. They focus on the inflation outlook in the medium term, which tends to be driven by the economic outlook. Hence, the Federal Reserve’s focus on continued above-trend economic growth and strong job growth as being the main indicators necessary for it to start to raise interest rates soon. Although measures of long-run inflation expectations derived from Treasury securities have fallen, this seems mainly due to oil prices. We still expect a September Fed rate hike. The subsequent rate cycle will be very slow though.