Why commodities were cool to the Fed

Rajalakshmi Nirmal | Updated on March 10, 2018



All eyes will now be on Chinese growth

After keeping its interest rates close to zero for six years, the Federal Reserve last week raised rates by 25 basis points. But other than oil, no other commodity in the global market has reacted sharply. In the case of oil too, the reaction was partly due to the news of higher US crude inventories.

The key reason for the Fed rate hike turning a non-event for commodities was that the news was already discounted by the market. Commodities from oil to base metals and gold have been in a freefall since 2012, even as the US Fed began to talk of tighter money policies. The US Dollar index (which measures the value of the greenback against six major currencies) has rallied since then to hit the 100-mark, gaining 24 per cent. Copper and aluminium have dropped 30 per cent and gold has plunged almost 50 per cent.

The stronger dollar against their home currency has also propped up realisations and prompted metal and mining giants to protect their realisations against falling commodity prices. Take, for instance, the case of Chilean copper miners. Since all of their output is sold in the international market in dollars and the Chilean peso had dropped 15 per cent against the dollar in 2014 and 2015, the producers reported higher realisations on every tonne of copper sold.

Similarly, the fall in prices of steel and nickel didn’t impact producers in Russia as much. As the rouble weakened by about 30 per cent against the greenback in 2015, they maintained their output.

Supply spike

But the higher output in commodities could still have been absorbed had the Chinese economy continued with business as usual. The country, which consumes about half the global output in metals and is the second-largest consumer of oil in the world, has seen the economy falter and demand drop in 2015.

From an average of 9-9.5 per cent in 2012, China’s GDP growth dropped to 7 per cent in 2014 and in the recent September 2015 quarter to 6.9 per cent. Its imports have also been recording a drop month after month — a stark contrast to the period between 2005 and 2011 when double-digit growth was the norm.


The outlook for commodities from hereon depends on two factors — the direction of the US dollar and the prospects for China.

If history repeats itself, the dollar could possibly lose its strength after the first or second rate hike by the Fed.

Data for the last 20 years show that during all three previous rate upcycles, the dollar did weaken. In 2004, between June and December, as the Fed fund rate moved up from 1 per cent to 2.25 per cent, the US dollar index dropped 9 per cent. Similarly, in 1994 and 1999 also, the dollar lost out to other currencies as rates moved up.

If this scenario plays out again and the dollar does not appreciate very strongly, buyers of raw materials across the globe will see their spending power improve. This could stoke demand for metals and gold.

China matters more

The super-cycle in commodity prices that lasted from 2008 to 2011 ended mainly because of the slowdown in China. Now, even if China’s breakneck growth doesn’t return, a modest recovery can help revive commodities.

Beijing now has a stated goal of doubling its GDP in 2020 from 2010 levels, which means a growth of about 6.5 per cent annually over the next five years.

This is slower than the 7 per cent growth posted recently, but points to some investments in Chinese infrastructure and housing in the coming years which can lead to moderate demand.

Researchers say that zinc, silver and palladium should fare relatively better in 2016, due to lower inventories and not much excess supply.

Oil may continue to be hit by oversupply, though China may make up about a fourth of the incremental demand for the fuel.

Published on December 20, 2015

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