Since March a banking crisis has weighed on the US dollar while propelling gold to near-record highs. Commodity price support from a weaker USD may prove fleeting, not least if interest rates at 15-year highs and tightening credit exacerbate a looming Atlantic Basin recession. China’s role in helping keep the global economy’s “head above water” has therefore come into ever-sharper focus.
Financial and commodity markets remain spooked by the ebb and flow of a nascent banking crisis which, although so far less pervasive than in 2008, has nonetheless driven an investment exodus from riskier assets. Last weekend’s collapse of First Republic was the third US bank failure since March and the second largest bank failure in US history. A fourth institution – Pacific West – is reportedly seeking a financial rescue package. US regional and European banking stocks remain respectively 34% and 13% below early-March levels. At writing, ICE Brent futures are again in the low $70s, a level that prompted core OPEC+ members to intervene barely a month ago.
The US dollar and gold have both historically played safe-haven roles during periods of market turmoil, although recent co-movement between them has become distinctly inverted. Early-2023 expectations of sustained US interest rate hikes saw renewed dollar appreciation, but a corresponding sell-off in gold. Since March, these trajectories have reversed, with gold now nearing record highs, while the USD index has fallen by 4% since early-March. Market predictions of further short-term dollar weakness hinge upon looming US recession, political stalemate over raising the Federal government debt ceiling, de-dollarization initiatives from the BRICS economies and (arguably premature) expectations of imminent Fed. policy loosening. The dollar’s role as the dominant global currency for trade, debt issuance and international payments is unlikely to be usurped in the short-to-medium term. Nonetheless, Washington’s broadening adoption of financial sanctions as a foreign policy tool and G7 embargoes on Russian merchandise trade, are encouraging alternative settlement mechanisms, pushing the dollar’s share of foreign exchange holdings below 60% in 2022, from over 70% at the turn of the 2000s.
More importantly for short term dollar value though, the US Federal Reserve seems unlikely to reverse a year of policy tightening anytime soon. For now, the battle against inflation remains a priority, even if financial sector fragilities and imminent Atlantic Basin recession imply rates may now be near their peak. The US Fed and ECB both raised interest rates this week by a further 25 basis points, taking the cost of capital in both regions to its highest in over 15 years. A delicate balancing act for the rest of 2023 will now see central banks attempt to maintain downward pressure on inflation (which unexpectedly ticked higher in April for the Eurozone) without also exacerbating banking sector volatility, choking off credit or worsening a looming recession and rise in unemployment.
Away from the financial markets, global manufacturing is also in the doldrums, with major market PMIs all in contraction during April. Nonetheless, the Chinese economy is recovering after the authorities relaxed zero-Covid policies in place for most of 2020-2022. As we noted last month, China’s economic performance takes on added importance in 2023 since anticipated 5% growth there is in such stark contrast to the stagnation (at best) expected for North America and Europe. But Chinese recovery so far remains heavily reliant on government stimulus, with the real estate sector, responsible both for 25% of GDP and a significant proportion of raw commodity import demand, remaining in contraction. It is hard to envisage a major commodity bull run – whether for crude, diesel, iron ore or copper – if Atlantic Basin recession and a Chinese real estate slump persist in tandem.
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