Market forces determine medium and long-term interest rates, but the US central bank sets the short-term Fed Funds rate. Setting short-term rates is the most powerful tool in the central bank’s monetary policy toolbox.
The Fed lifted off from a zero percent short-term rate environment at the March FOMC meeting, increasing the Fed Funds Rate to a range from 25-50-basis points. The market’s consensus for this week’s meeting is for another 50-basis point hike and a plan for reducing the Fed’s swollen balance sheet. Balance sheet reduction will put upward pressure on rates further out along the yield curve as the Fed allows debt securities to roll off at maturities. Interest rate policy impacts markets across all asset classes, and markets began preparing for the Fed meeting over the past weeks.
The dollar index soars with help from the Bank of Japan and Europe
Rising US interest rates and the war in Europe support a higher US dollar index as it measures the US currency against other world reserve foreign exchange instruments. The index has a 77.3% exposure to the euro, British pound, Swedish krona, and Swiss franc. The index also has a 13.6% exposure to the Japanese yen. Last week, the Bank of Japan reiterated its commitment to low interest rates, which provided additional support for the dollar index.
The chart shows the dollar index rose to a high of 103.950 last week, only 0.01 below the March 2020 high, which was the highest level since 2002. Rising US interest rates are putting upward pressure on the US dollar versus the components of the dollar index.
Meanwhile, a bullish trend in the dollar is typically bearish for commodity prices as the dollar is the pricing benchmark for most raw material markets. As the dollar rises, it pushes commodity prices higher in other currencies, inhibiting buying and encouraging selling or substitution for less expensive alternatives. Moreover, rising interest rates increase the cost of carrying inventories, adding downside pressure to commodities. However, 2022 is anything but an ordinary year as many commodity prices remain near multi-year or all-time highs. Inflation, supply chain bottlenecks, sanctions and retaliation, and other factors have trumped currency and interest rate differentials.
Precious metals declined
Nearby COMEX gold futures rose to a new all-time high of $2072 in early March. The precious metal corrected to just over the $1860 level on May 2. COMEX silver futures reached over $27 per ounce when gold was on the high, but the price retreated to around $22.50 on the first trading day in May. NYMEX platinum futures moved to $1154 before falling to below $930 on May 2, and NYMEX palladium futures plunged from the $3,380 level to below $2,200 per ounce in early May.
The strong dollar and increasing interest rates weighed on the precious metals sector, but it remains in a long-term bullish trend as it awaits the May 4 FOMC meeting.
Energy remains stable at high prices
Nearby NYMEX crude oil futures were above the $100 per barrel level on May 2, with gasoline and heating oil, a proxy for other distillate fuels, at high levels. Crack spreads, the processing margins for refining petroleum into oil products remain at historically high price levels. The demand for fuel is robust with supply concerns because of sanctions on Russia. Higher interest rates and a strong dollar have pushed prices lower from the March highs, but they remain at the highest levels in years.
US natural gas prices for June delivery were above the $7.40 per MMBtu level on May 2, with European and Asia prices at much higher levels. Last week, Russia banned natural gas exports to Poland and Bulgaria, causing supply concerns throughout Europe and increasing demand for US LNG exports. According to the Energy Information Administration, US natural gas inventories were 21.4% below last year’s level and 17% under the five-year average for the week ending on April 25, 2022.
Agricultural commodities are near the highs
At the start of the 2022 growing season in the northern hemisphere, grain and oilseed prices are at lofty levels. Nearby CBOT soybean futures were near $16.50 on May 2, and the all-time 2012 high stands at $17.9475. Nearby CBOT corn futures were at the $8.00 per bushel level with the all-time high from 2012 at $8.4375. CBOT wheat futures rose to a new all-time peak of $14.2525 in March and corrected to the $10.57 level on May 2. At over $10 per bushel, wheat is at the highest price level since 2008.
Meanwhile, over the past weeks and months, coffee, cotton, frozen concentrated orange juice, and sugar prices rose to multi-year highs along with other agricultural products.
Inflationary pressures and supply chain issues have increased production costs. The war raging in Europe’s breadbasket and critical logistical hub at the Black Sea ports and a Russian fertilizer export ban to “unfriendly” countries have put additional upside pressure on agricultural commodity prices.
The Fed is secondary as geopolitics is at the center of the stage in 2022
The Fed will likely increase the short-term Fed Funds Rate by 50 basis points on May 4, which has pushed the dollar higher. However, interest rates and currency differentials have taken a backseat to geopolitics in 2022.
Moreover, the Fed remains far behind the inflationary curve, with consumer and producer price increases at the highest levels since the early 1980s. Inflation is a challenging beast in 2022, and it will likely take more than monetary policy to get the economic condition under control. The commodity markets have mostly corrected going into the FOMC meeting, but we could see a sell the rumor and buy the fact reaction after the Fed makes its next monetary policy move. I believe the markets will tell the central bank it has not gone far enough on the interest rate front, and we will see the rallies that began in early 2020 continue throughout 2022 and beyond.
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