NY futures came under severe pressure this week, as March dropped 435 points to close at 75.06 cents/lb.
After spending 65 sessions in a relatively tight settlement range of just 463 points, March finally abandoned the 3-month sideways trend yesterday and resumed its primary downtrend, which had originated in early June. Today marked the lowest close for the March contract since late January and from a spot month perspective we have now lost over 21 cents, or 22 percent, since the July contract posted an intra-day high of 96.40 on May 31st.
Cotton is in good company though, as other industrial commodities have been hammered as well. Crude oil is down by over 30 dollars/barrel or nearly 40% since early October, Lumber is down 50% since May and Copper has dropped around 16% since June. Meanwhile the Dow Jones Industrial index is down 14% since the beginning of October and sits today at its lowest level in fourteen months.
These weak markets, along with declining consumer and business confidence, seem to foreshadow a global recession next year. What started on the periphery with a currency crisis in several emerging markets this summer has now worked its way to the core, as the US, Europe and Asia are all experiencing slower growth and liquidity problems.
However, the Federal Reserve doesn’t see it that way, as it still believes in a strong US economy going forward, with GDP growth expected to top 2% in 2019. As a result the Fed hiked its federal funds rate by another 0.25% yesterday. This was the 8th rate increase in two years, as the fed funds rate has gone from 0.5% to 2.5% since December 2016.
We believe that the Fed is once again behind the curve, since it is relying on lagging indicators, while markets and confidence readings are forward looking. However, a 2.5% fed funds rate is still very low by historical standards. In the early 1980s the rate was at 20.0%, something that is unthinkable now given the current debt load. Even in the year 2000 the rate was still at 6.5% and only since the 2008 financial crisis have we seen the fed funds rate in this low range between 0.25% and 2.5%.
Unfortunately this global bubble economy is dependent on cheap money in order to keep going. According to the Institute of International Finance (IIF), global debt amounted to USD 247 trillion in Q2, while the global GDP-to-debt ratio was at 318%. Therefore, it is no wonder that when the cost of servicing this massive amount of debt rises, all kinds of problems ensue.
However, while the Fed anticipates two more rate hikes in 2019, we believe that this won’t happen and that the next move will be a reversal towards lower rates. The economy is clearly starting to roll over and the Fed will once again have to come to the rescue with more cheap money and possibly another round of QE.
We still believe that the end result of this monetary experiment central bankers have been running since the early 2000s will be “stagflation”. Economies will struggle to grow in real terms, while the purchasing power of all fiat currencies continues to erode at an accelerating pace.
We expect the US dollar to lose its relative strength going forward. A weakening economy, escalating twin-deficits of probably 1.6-1.7 trillion dollars in fiscal 2019 and a lower yield spread vis-à-vis other currencies will turn into strong headwinds for the greenback, probably as early as the first quarter. This should help to stabilize commodities.
If we are correct with our assumptions, it would mean that nominal values of all financial assets will eventually get pumped up again, although there might be some more pain ahead in the short term.
Outside markets clearly dominated the headlines this week and there wasn’t much in terms of cotton-specific news. We still see global production and mill use trending lower and we wouldn’t be surprised if the two numbers ended up at a similar level, somewhere near 118 million bales. This would mean that there is going to be plenty of cotton available to get us comfortably through the season.
US export sales of Upland and Pima cotton were better than expected at 154,100 running bales for both marketing years. Cancellations were small this week at just 12k in four markets, but that's a feature that's probably going to stick with us for a while. Shipments of 164,400 running bales remained relatively slow. For the season we now have commitments of 10.75 million statistical bales, of which just 3.2 million bales have so far been exported. For the coming season sales are still at 2.15 million bales.
So where do we go from here? There is currently quite a bit of pessimism regarding the global economy and the world’s financial markets. This negative sentiment is not going to change unless we have a resolution to the US/China trade dispute and/or the Fed changes its hawkish stance.
Against this backdrop it is difficult for cotton to gain strength, especially after all kinds of important technical support levels have been breached this week. The path of least resistance is therefore down, with the next target being 72-73 cents.
As anticipated, we are seeing carrying charges being built back into the market, with the March/July spread going from 161 points to 264 points carry since last Thursday, while the March/Dec spread has narrowed from a 198-point inversion to 22 points carry. We expect this development to continue, as the market needs to create an incentive to carry the large amount of unsold 41-style cotton.
We wish all readers a peaceful, happy Christmas.
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