No need for commodities investors to worry too much over Fed rate increase, analysts say

PUBLISHED : Thursday, 29 October, 2015, 2:49pm
UPDATED : Thursday, 29 October, 2015, 11:56pm

US interest rates have long been regarded as critical in determining the outlook for commodities, but some analysts say investors need not worry too much about the US Federal Reserve reversing its monetary stimulus efforts in the near term, because commodity prices could rally even as US interest rates return to more normal levels.

Julian Jessop, chief global economist for Capital Economics, said in a report on Wednesday that it was widely assumed an increase in US interest rates might lead to lower commodity prices, as higher rates could result in slower economic growth, reduced demand for commodities, and increase the opportunity cost for investors holding commodities.

Others see Fed tightening boosting the US dollar, which tends to have a negative impact on commodity prices, as they become more expensive for holder of other currencies, and higher interest rates making it more attractive for producers to increase output and invest the proceeds in financial assets for a better return, thus potentially boosting supply.

However, Jessop said commodity investors might not need to worry too much about a Fed interest rate increase in the near future because real interest rates could remain low.

The fallout from the earlier slump in commodity prices is likely to have a much bigger impact on supply
Julian Jessop, Capital Economics

“The upshot is that if the Fed is raising nominal interest rates to counter rising wage and price pressures, the net effect on real interest rates (and on demand for inflation hedges such as gold) could be zero,” he said.

Commodities were real assets whose prices usually rose in line with inflation, he added.

More importantly, it was “unlikely” US official interest rates would rise very far, he predicted.

Capital Economics forecasts the Fed funds rate might increase to around 2 per cent in 2016 and 3.5 per cent in 2017.

“This in turn implies only a small change in the opportunity cost of holding commodities,” he said, adding that there could be no change at all if the rate rise was offset by an increase in the general level of inflation.

Similarly, earlier declines in global commodity prices might lead to a reduction of supply and ease the pressure on prices.

“The fallout from the earlier slump in commodity prices is likely to have a much bigger impact on supply than any boost from a small increase in potential investment returns from producers and in the costs of carry inventories,” he said.

Last but not least, Jessop did not see broad, strong momentum for the US dollar against other major currencies going forward.

Although central banks in the Europe, Japan, and China might loosen policy further, which could put some “renewed upward pressure” on the US dollar, “the bulk of the dollar’s appreciation is now in the past”, he said.

In the meantime, Jessop said, signs of hope for the global economy, and especially the Chinese economy, should support many emerging market currencies.