Monday, November 15, 2010

Commodities And Credit Report

Commodities: Prices are surging

Commodity prices have surged over the past couple of weeks. Copper has traded at an alltime high of USD8,980.50, oil prices have reached a 25-month high, and grain prices continue to surge, hitting levels not seen since September 2008. Last week’s rally was particularly remarkable as it happened despite the dollar regaining strength and all the concerns about the debt crisis in Europe.

It seems as if the commodity markets have come to the conclusion that the new round of quantitative measures from the Federal Reserve and decent economic numbers from the US (e.g. positive non-farm payrolls report and ISM indicator last week) make a very upbeat combination for commodities. The IMF warned in its latest World Economic Outlook that the so-called ‘super-cycle’ in commodities could be about to resume. We agree, and when we consider strong Asian demand and tighter market balance in several
commodities, we should be careful about dismissing the latest price rises as pure speculation.

There will still be setbacks…but be careful not to miss the boat
Commodities are of course not immune to setbacks in risk appetite. However, we think consumers in particular should be careful not to wait for significant setbacks in energy and base metals. In doing so, they risk missing another leg higher in prices that certainly cannot be ruled out at the moment. We might ourselves have underestimated the strong sentiment in commodities. Oil might not be trading in a new USD80-90/bbl range as we have been calling for. Instead it seems that a test of USD100/bbl could come much earlier than late 2011 that we previously anticipated. The calls for copper reaching USD10,000/t also no longer look outrageous.

Oil market fundamentals improve
In the oil market we have lately seen a clear improvement in oil-specific fundamentals. According to Reuters, implied demand in China rose an impressive 12.9% y/y or 8.92  mb/d over the past four weeks. Hence, the strong growth in the Chinese economy is feeding into the oil market. But the US market has also improved. The weekly US oil stock data showed a surprise drop in crude inventories, and US implied demand is now
running at a strong 2.9% y/y over the past four weeks. If the positive numbers continue and the dollar starts to weaken again – as we expect – a test above USD90/bbl looks likely.

Credit : Peripherals under pressure
Market commentary

In recent days, focus has once again turned to peripheral sovereign concerns. The European debt crisis took another turn for the worse on Wednesday after another meltdown in the Irish debt market. Benchmark 10-year Irish bond yields got hammered again, rising 40bp to 8.7%. As a result, the spread to German bunds soared to a record 619bp. Portuguese, Greek and Spanish bonds also took a hit. The sell-off was fuelled by a fire sale from investors unable to meet increased margin requirements enforced by LCH.Clearnet – one of Europe’s biggest clearing houses. Peripheral sovereign CDS also moved wider, although less than cash spreads. iTraxx Main and Crossover currently trade around 105bp and 460bp, 8bp and 30bp wider than last Friday, respectively. As usual, when sovereign concerns resurface, iTraxx Senior Financials underperforms and it is 17bp wider at 149bp.

The G20 summit meeting beginning today in Seoul could prove important for the future direction of the credit market. The currency war issue and the Fed’s policy of printing more money are likely to top the agenda but finalisation of Basel III and avoiding protectionism will also be important points. However, we do not expect much substance to result from the summit. According to FT, G20 is drawing up a two-tier bank plan where around 20 global banks, whose failure would pose a risk to the international financial system, will be subject to greater regulatory scrutiny, while remaining domestically focused institutions will be left to domestic regulation. FT also reported that G20 might defer a decision on whether there should be a globally set capital surcharge for systemically important banks.

The primary market
Although volume has come down somewhat, the non-financial primary deals launched during the week have performed well despite the peripheral sovereign widening. During the week, we have seen new issuance in the covered bond space while senior financial supply has been muted. We would not be surprised to see thin volume through the rest of the year in the primary market if the current sentiment continues, as investors are
currently defensive and many issuers are pre-funded.
Full report: Commodities And Credit Report

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