Predictions That the US Debt Ceiling Will Be Encountered Again
While the Greek debt negotiation appears to have ended favorably, the markets seem to remain somewhat skeptical, and it could take a period of calm to fully tamp down anxiety. However, some portion of the worst-case scenario seems to have been eliminated or reduced, at least for the time being, by the most recent debt agreement. While the US economy has been showing some signs of improvement, the rest of the world remains highly suspect, and most central bankers still appear to be poised to err to the side of too much easing as opposed to prematurely raising the inflation-fighting flag. Clearly the EU and many other countries like the US have some serious challenges in floating the debt necessary to continue to operate their governments into the future. Even in the US, where some positive economic activity is surfacing, there are predictions that the US debt ceiling will be encountered again as early as the middle of June, and that suggests debt and deficits will continue to worsen unless the pace of global growth is accelerated. Therefore, a long list of central bankers and politicians have been put into a position where they have to continue to provide assistance to the economy until there are very definitively strong signs of sustainable growth.
Even the stalwart inflation-fighting PBOC has recently relented and has apparently shifted back into an easing posture. Last week the BOE and BOJ joined the easing parade, and it goes without saying that the EU will have to continue to do everything in its power to prevent the Euro zone from falling back into a serious recession. With the added pressure of high energy prices and the prospect of a rather sticky geopolitical price premium in energy prices into the implementation of the Iranian oil embargo this summer, inflation pressures could be poised to surface. Certainly the prospect of inflation will be held in check as long as the world economy remains off balance, but in the event the US economy shows even more life in the wake of calmer European waters, that could in turn put the US economy in enough forward motion to foster initial price pressures, which in turn would quickly spread beyond the oil and metals markets.
In looking at a chart of consumer confidence, it is clear that the European crisis has held back the world economy for almost the better part of a year. Therefore, seeing a drought of bad news from that area for a couple weeks could easily equate to a global QE3-type stimulus.
While it might be premature to suggest the US would release oil from the SPR, gasoline prices are already hurting the US economy at the pump, and it is an election year! Therefore, one should not be surprised to see the US and perhaps even the IEA at least threaten to release some oil, as the European crisis could be effectively ended if officials can manage to extend the positive euphoria seen off the Greek debt deal.
In looking at a chart of speculative positions in non financial commodity markets, it is clear that many commodity markets have seen a significant leveling of speculative holdings, and those players could be pulled back into the long side with something as simple as a minimally positive global economic outlook!
The extremely tight old crop ending stocks outlook continues to provide underlying support to the corn market, and the outlook for a surge in production and ending stocks for the 2012/13 season continues to keep a lid on advances. News from the baseline USDA data released a few weeks ago was viewed as a mixed bag. China import demand is expected to grow significantly in the next ten years. However, the baseline data also shows that US corn planted area for the 2012/13 season would be at the highest level since 1944, with a record production this season. It also showed ending stocks more than doubling from 801 million bushels for the 2011/12 season. Yield was pegged at 164 bushels per acre for the 2012/13 season, and trendline yield advances to 182 by 2021/22.
Weather is still a factor in South America, as Brazil's second crop season is just beginning, with the crop about 30% planted. Weather is already a concern in the Midwest with dry conditions reported in the western Corn Belt and parts of the northern plains. If the early spring weather is dry, bulls will point to yield concerns in the US and dry soil conditions in the grain belt in China, but bears will likely win out as corn plantings will jump to a fast start. This may increase the odds of planted area coming in even higher than expected.
The Commitments of Traders reports as of February 14th showed non-commercial traders were net long 228,687 contracts, a decrease of 4,626 contracts for the week. The selling trend is seen as a negative force. Non-commercial and nonreportable traders combined held a net long position of 95,430 contracts, down 11,820 for the week. Open interest is up 103,456 contracts over the past month, but the market has mostly traded in a choppy and sideways pattern since January 24th. The chart pattern for new crop corn is negative with a series of lower highs since the August 31 contract highs on November 9, January 3 and February 6. Considering the hefty net long position from the fund traders, higher open interest and the weak pattern, don't rule out a continued downtrend into the planting season.
November soybeans have seen a strong rally off of the December lows, and with the outlook for smaller production from South America, smaller planted area in the US and a continued uptrend in Chinese demand, the market may be making one last rally effort in order to steal some acres from the corn market. Ideas of lower South American oilseed production plus losses to the rapeseed crops in Eastern Europe and China this winter helped to support the soybean oil market, with December oil moving to its highest level since September 21 on the rally into February 21.
The USDA Supply/Demand report for February was considered slightly negative for soybeans, but traders believed that the USDA did not update the market on the full extent of losses due to drought in South America. Many traders expect to see another 4-5 million tonne loss in the South America production for the March report. The emergence of China as an active buyer and bullish outside market forces have added to the more positive tone. Brazilian production came in at 72 million tonnes versus trade expectations near 71.3 million tonnes. Argentina's production was 48 million tonnes, down from 50.5 million in January and right on trade expectations. In the first official crop estimate for Argentina, the Farm Minister pegged the crop at just 43.5 to 45 million tonnes. This was also down from the Buenos Aires Grains Exchange estimate of 46.2 million tonnes. China has been an aggressive buyer in recent weeks. The US Soybean Export Council indicated that the Chinese delegation inked agreements to buy 13.4 million tonnes of US soybeans during the week of their visit.
The COT report as of February 14th showed non-commercial traders were net long 100,178 soybean contracts, an increase of 19,431 for the week. The aggressive buying trend is seen as a short term positive force. The outlook for declining US and world ending stocks for the coming year, expanding global demand from China, the surge in energy prices, the easier monetary policies around the world are all factors which might attract increased demand from fund traders ahead.
The US Dollar went through some choppy and volatile price action during the past few weeks, as macroeconomic sentiment continued to rise and fall with every fresh development out of the Euro zone. The main focus of the market was on the negotiations for a second Greek debt bailout, which reached a climax at the EU Finance Ministers meeting last week. While an agreement was eventually hammered out, there is still quite a bit of skepticism that this plan will be successful. However, there has been a clear reduction in market anxiety as many global financial markets have already shifted back to a "risk-on" mentality. This has put considerable pressure on the Dollar and the Japanese Yen, the two main destinations for a flight to safety out of the Euro zone. The British Pound also fell back from recent highs, but that move may have been overdone given the currency's strength so far in 2012.
In addition to the headwinds coming across the English Channel, the March Pound had to deal with the prospect for fresh quantitative easing measures for the UK economy. At their February monetary policy meeting, the Bank of England decided to buy 50 billion Pounds worth of assets over the next three months. When the meeting minutes were released last week, it was revealed that two members voted for a larger amount of quantitative easing. Many traders felt that this was a signal that additional easing action would be taken later on this year.
However, this month's UK economic data has generally exceeded expectations and may have diminished the chances for further quantitative easing activity. Although UK inflation has fallen back from last year's high levels, it remains comparatively high relative to other major global economies and could act as an additional brake on further easing measures. Last week's pullback took the March Pound well below the early February price levels, and may provide an opportunity to enter the long side of a market that could easily reach new high ground for 2012 during the near future.
The US Treasury market is showing signs that the next move outside of the 2012 congestion zone is down. The June 10-Year Note contract has spent the first two months of 2012 inside of a tight three point trading range, from 129-16 to a contract high of 132-05. The latest round of US economic data has shown continued improvement in the labor market, expanding US manufacturing activity and modest signs of inflation. With the European debt situation appearing to be on the mend, there is an increasing chance that the Treasury market will shift its focus towards improving growth expectations and higher levels of inflation.
The favorable trend to US economic data readings have continued in 2012 and has at times pressured prices on 10-Year Notes. While the June contract registered a new contract high on February 5th, much of the gains were fueled by flight-to- quality buying, as Greek and European leaders hammered out an arrangement for a second bailout. But with that out of the way and US economic data continuing to improve, the prospect for lower US Treasury prices is a growing probability. A recent example of this came following US initial jobless claims data on February 16th that showed new claims falling to a new four year low. Inflation pressures also appear to be cropping up, highlighted by the yield differential between 10- Year Notes and 10-Year TIPS. This spread relationship has climbed to its highest level since mid-August of 2.27%, and that shows the presence of inflationary expectations rising in the Treasury market. The January Consumer Price Index showed a monthly gain of 0.21%, largely attributed to a 0.9% gain in gasoline prices. Estimates provided by the EIA show US retail gasoline prices increasing by more than 10% in the first two months of the year.
A number of US Fed officials have talked recently about the risks of an artificially low US interest rate environment. Comments by St. Louis Fed President James Bullard in early February highlighted his concerns over the period of extremely low interest rates, suggesting that it could hurt the US economy in the long run. Dallas Fed President Richard Fisher adopted a similar tone, telling Wall Street not to expect QE3 or any further central bank participation. Fisher also noted that the US economy had improved since the Fed's vow to keep US interest rates low out to 2014.
In one sense, the European debt debacle has helped the US Treasury with its active 2012 auction calendar. But there is a possibility that the market will demand higher interest rates for US debt as the global economic backdrop improves, and this could apply greater downside pressure on June 10-Year Notes. The market has struggled to gain any upside recently, despite concerns over European debt and the potential for a hard economic landing in China. While there is a chance for additional safe-haven support coming into the US Treasury market, we suggest looking to May options to position for a breakdown in prices.
***This report includes information from sources believed to be reliable and accurate as of the date of this publication, but no independent verification has been made and we do not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase or sale of a futures contract and/or commodity option thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition. Any reproduction or retransmission of this report without the express written consent of The Hightower Report is strictly prohibited.
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