MACRO Macchiato 2024 07 29
We are, it is generally acknowledged, near the top of the interest rate cycle. Since 2022, the US Federal Reserve has steadily increased interest rates from 0.25% to 5.50%. The European Central Bank (ECB) started with rates at 0.00% and has increased them to 4.50%. The People's Bank of China (PBOC) has gradually lowered rates from 3.85% to 3.25%. The Bank of Japan (BOJ) has maintained a stable interest rate at -0.10%.
The consensus expectation is that the US Federal Reserve will cut rates by approximately 100 basis points in 2024, leading to a target federal funds rate of around 3.75% by year-end.
The ECB is projected to reduce its refinancing rate to about 3.50% by the end of 2024, is in line with the general expectation that the ECB will begin to ease monetary policy as inflation moderates and economic activity slows down
While the outlook for China is less clear, the general expectation is for the People's Bank of China to maintain a accommodative stance, potentially lowering rates slightly to support economic growth amid domestic deflation and global uncertainties.
The Bank of Japan is anticipated to keep its ultra-low interest rates unchanged, possibly around -0.10% to 0%, as it continues to combat low inflation and stimulate economic activity. There is no strong indication of significant changes in the BOJ's policy stance for 2024.
These expectations reflect a broader trend of central banks potentially easing monetary policy as inflationary pressures diminish and economic growth slows. However, the precise adjustments will depend on the evolving economic conditions and inflation trajectories throughout the year.
The upshot is that, all other things being equal, interest rates should be lower on average at the end of 2024 than they are today. That should make borrowing to invest in capital projects less expensive, as well as making consumer credit and mortgages cheaper. The hope is that consumers will spend their windfall, promoting further economic growth.
Consensus forecasts for the value of the USD against a basket of major currencies indicate a mixed outlook for 2024. Several factors suggest that the USD may experience moderate depreciation due to various factors, including potential changes in interest rate differentials and global economic conditions.
Moderate Depreciation Expected: The USD is expected to depreciate modestly in 2024 as the factors supporting its current elevated value, such as wide interest rate differentials and US economic outperformance, may begin to unwind. However, significant depreciation may be limited as the Federal Reserve might maintain higher interest rates longer than other central banks. There is the complication of the presidential election. Mr Trump has been clear that he likes low interest rates – and a compliant Federal Reserve. Ms Harris has been less forthright.
Impact of Geopolitical Risks and Economic Conditions: Geopolitical risks and economic performance differentials will play a significant role. For instance, the performance of the US dollar might be supported by flight-to-safety flows in the event of economic or geopolitical turmoil. Conversely, easing inflation and lower interest rates in the US could lead to a weaker dollar. The greenback is “our currency but your problem.” It is also more exposed to external pressures in the context of geopolitical uncertainty.
Currency Specifics:
JPY: The Japanese yen is expected to appreciate in 2024 as the Bank of Japan may tighten its monetary policy modestly due to rising inflation and a tightening labour market. The yen is currently very weak, which is great for overseas companies ordering ships at Japanese shipyards. We used to say that anything weaker than JPY 130 to the USD was a signal to order in Japan. Currently one dollar costs JPY 154.
EUR and GBP: The euro and sterling may also see some appreciation against the USD, especially in the latter part of the year, driven by relatively better economic growth prospects in the Eurozone and potential fiscal measures in the UK Overall, while the USD may depreciate slightly against a basket of major currencies, significant fluctuations will likely be tempered by ongoing economic and geopolitical dynamic
The Relationship Between Interest Rates and Commodities
Commodity markets are profoundly influenced by macroeconomic variables, with interest rates being one of the most significant factors. As central banks around the world adjust interest rates to manage inflation and economic growth, the ripple effects are felt across various commodities such as gold, oil, and agricultural products. Understanding these dynamics can help investors and traders navigate the complex interplay between monetary policy and commodity prices.
Cost of Carry:
Interest rates directly affect the cost of holding (or carrying) commodities. When interest rates rise, the cost of financing the storage and purchase of commodities increases, which can depress commodity prices. Conversely, lower interest rates reduce these costs, potentially boosting commodity prices. For instance, gold does not generate interest or dividends so it becomes less attractive when interest rates rise because the opportunity cost of holding gold increases compared to interest-bearing assets. Currently gold investors are in bullish mode.
Currency Fluctuations:
Commodities are often priced in US dollars. Interest rate changes in the US can affect the value of the dollar. A higher interest rate tends to strengthen the dollar, making commodities more expensive for foreign buyers and potentially reducing demand. Conversely, a weaker dollar makes commodities cheaper and can increase demand. More demand for commodities should mean more demand for shipping them.
Inflation Expectations:
Commodities are often seen as a hedge against inflation. Higher interest rates are usually implemented to combat inflation, which can reduce the appeal of commodities as an inflation hedge. However, if inflation expectations remain high, demand for commodities may stay robust despite higher interest rates. During periods of high inflation, investors flock to gold despite rising interest rates, maintaining or even increasing its price.
Sector-Specific Impacts
Energy Commodities:
Oil and Natural Gas are highly sensitive to economic growth prospects. Higher interest rates can slow down economic activity, reducing demand for energy. However, geopolitical factors and supply constraints can offset this effect. Investment in renewable energy projects can be affected by higher interest rates, as the cost of capital increases, potentially slowing the transition to greener energy sources.
Metals:
Industrial Metals: Metals like iron, copper and aluminium are closely tied to industrial activity. Higher interest rates can slow down construction and manufacturing, reducing demand for these metals. China has been lowering interest rates to get the construction industry going, but so far its cuts have been insufficient to increase demand for steel, prices for which have fallen by about a third this year.
3. Agricultural Commodities:
Grains and Livestock: Higher interest rates can increase the cost of financing for farmers, affecting their production costs and potentially leading to lower supply. Additionally, consumer spending on food can be impacted by higher borrowing costs, influencing demand.
Broader Economic Implications:
Investment Flows: Higher interest rates in developed markets can attract capital flows away from emerging markets, leading to currency depreciation in those markets and affecting their commodity trade balances.
Speculative Activity: Interest rates influence speculative trading in commodity markets. Lower rates can lead to increased speculation as cheap money flows into commodity futures and other derivative products.
What Does It All Mean For Shipping?
In shipping, we are most interested in US interest rates as they affect the value of the USD, which in turn has an inverse relationship with the Baltic Dry Index. When the greenback weakens, the BDI usually goes up. Does the prospect of a weaker USD therefore suggest we should go long on dry bulk freight markets? Understanding the inverse relationship between the USD and the BDI requires examining several key factors:
1. Commodity Prices and Demand
Many commodities are priced in USD. When the USD weakens, these commodities become cheaper for buyers using other currencies, potentially boosting demand. Increased demand for commodities often leads to higher demand for shipping services, which can drive up freight rates. If the USD depreciates, countries such as China or India may increase their purchases of raw materials like iron ore and coal, leading to higher shipping volumes and higher BDI values.
2. Trade Volumes
A weaker USD can stimulate global trade by making US exports more competitive and affordable for foreign buyers. This increase in trade volumes can elevate the demand for shipping services, thereby increasing freight rates.US agricultural products like soybeans and corn might see increased demand from countries with stronger currencies, leading to more shipments and higher freight rates.
3. Operational Costs
Many shipping companies incur costs in USD, such as bunker fuel and maintenance expenses. A weaker USD can reduce these operational costs for companies earning revenue in other currencies, potentially enabling them to offer more competitive shipping rates. However, the overall increase in demand usually outweighs this factor, leading to higher freight rates
4. Investment and Fleet Expansion
A weaker USD can influence investment in the shipping industry. For instance, non-US investors might find it cheaper to finance the construction of new ships, leading to a potential increase in supply capacity. However, this effect typically lags behind the immediate demand-driven changes in freight rates. If shipbuilding costs decline in USD terms, there might be more investment in new ships, potentially increasing future shipping capacity. This has been evident in Japan historically, as Japanese yards price ships in yen, whereas Chinese and South Korean yards price their ships in USD.
5. Global Economic Activity
The USD's value often reflects global economic conditions. A weaker USD might indicate a robust global economy, with higher industrial activity and increased demand for raw materials. This heightened economic activity generally leads to higher shipping demand and increased freight rates. A growing global economy with a weaker USD might see more infrastructure projects, higher production, and greater demand for raw materials, driving up the BDI.
Your Take-Away.
The USD should weaken this year due to several factors including falling US interest rates and stronger economic activity in US trading partners. A weaker USD typically results in higher ship freight rates as measured by the Baltic Dry Index. This is primarily due to increased global demand for commodities priced in USD, higher trade volumes, and potentially lower operational costs for shipping companies. The overall impact is a complex interplay of increased commodity demand, economic activity, and operational cost dynamics, all of which contribute to the inverse relationship between the USD and the BDI.
In summary of the summary:
If the Fed cuts rates, go long BDI.
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