COMMODITY FUTURES FORECAST WEEKLY REPORT
Fed Pops 1/4 As Expected
Philip Gotthelf
Okay. We all knew it was coming. The Fed raised the discount rate by 1/4-point in its "measured" tightening. Even with an inflation warning, fixed income and stocks yawned. And why not? This was exactly the Fed's objective. Essentially, Alan Greenspan does not want to make waves as we head down the presidential election home stretch.
With heating oil hitting new contract highs on July 1, I don't think inflation can be ruled out. In fact, moderate talk about inflation does not seem to jive with the figures. Even with setbacks in grain and meat prices, raw commodities remain supported. In particular, energy refuses to crack...no reference to the spread intended!
This means the Fed may accelerate raising rates to head off an inflationary burst as we move into the critical fourth quarter. So, why have Eurodollars moved up when short-term rates are supposed to be coming down?
Traders believe the Eurodollar's decline was overcommitted based upon an assumed pledge to take rates up a quarter notch at a time. Once everyone was confident this promise was in place, September Eurodollars had incentive to retrace and test 9800 resistance.
September Eurodollar
The chart illustrates a critical level because this resistance coincides with the 40-day average at 9799. As reported in today's Wall Street Journal, investors are turning bullish on everything from the 30-year down to the 5-year. After April began the significant bust in principle values and reciprocal rise in rates, spreads between the shortest rate and longer rates widened as though the Fed had already taken the discount rate up a full point.
I have annotated the 50% retracement from the "V" bottom to approximately 9823. Those viewing the .PDF file will see this in purple. Fed funds are at 1.25% while September Eurodollars are anticipating about 2%. Is .75% too much of a spread between overnight and 90-days? When you consider the September fed funds against the September Eurodollar, the spread hangs in around 30 to 40 ticks. This leaves the impression that September Eurodollars are in the right place. A 50% retracement puts the yield at 1.77%. But, the Fed is expected to bump rates another 1/2 by then.
Technically, a push beyond 9805 indicates a desire to test 50%. A bust below 9795 signals 9800 resistance has held and we are going lower.
The Economy
Unfortunately, economic reporting tends to be clouded by this year's politics. Reading between the lines, airlines, automobiles, and IT are lagging during the alleged boom. Consumer confidence is up, but we don't know the basis for optimism. Mortgage rates are higher and there has been a slowdown in mortgage applications. Housing starts are robust, albeit less than last year.
The economy looks like it could stall, regardless of Republican optimism. In a stalled economy, the Fed becomes reluctant to increase rates. This is the bet many fixed income traders are making as we move through the summer.
In addition, some economists point out that consumer debt has been fueled by low mortgage rates. As home borrowing slows, transaction velocity declines proportionally. Rising rates puts pressure on spending. This is one more reason the Fed must exercise particular caution when boosting short-term rates. Consumers have borrowed to their eyeballs and so has Uncle Sam. The assumption might be that deficits boost rates. Can a slowing economy offset the effects of deficit spending?
For some, Detroit's slowdown is based upon product rather than demand. Consumers want more from their vehicles and our Big Two or Big Three are haven't delivered. Toyota seems to have a lock on hybrids like Prius, Highlander, and Lexus ES400. Back orders exist for all three vehicles. Understand that these specialty cars are a small fraction of the total market. Such cars are not representative of broad demand.
The economy is not overheating as so many would like us to believe. Employment always skews in the summer with youth employment. I see consumers taking it easy as reflected by Wal-Mart's performance. This means the Fed may not be aggressive in raising rates...perhaps skipping the next opportunity to tap up by 1/4.
I have been intrigued by some of the volatility engendered by economic uncertainty. Consider the enthusiasm for September silver calls. From the put-to-call ratio, it seems obvious bulls are more interested in buying calls then bears are in buying puts. Look at the August silver calls. With a month to go, we can get better than 15 cents for 600 and protect ourselves with a 625 for about 8 cents.
Everyone is waiting for the new figures and the predictions are all over the place. There is always the possibility of a surprise, but I think Bush wants to save good news for the fall.
Are Cows Mad, Or Just Traders?
I must admit my amazement over Mad Cow developments since we shorted October feeder cattle on its bust below 10750 support. I alluded to last year's Mad Cow panic when comparing price charts. One subscriber called to accuse me of tapping into Uncle Sam's test results ahead of the news. That compliment aside, I was relying upon the technical prospect of a setback based upon the assumption that a breach of 10750 would be followed by a test near 10600. Indeed, we achieved our first objective, but not purely on technical projections. The proof of our analysis rests with achieving the second, and aggressive 10377 goal.
Even with suspected disease, feeders have been resilient. This is why we cannot assume victory until 10377 is achieved. The false positive test alleviates concern that cattle will collapse. However, a second potentially false positive animal is still awaiting a final diagnosis.
Prices managed to dip below the support channel line, but the interlude was brief. This morning's action suggests feeder cattle can resume its upward trek. Moreover, the June 29 bust left a gap that could be itching to be filled.
If the National Weather Service forecast is correct, most of the country will be moving cookouts in.
The country is peppered with intertwined high and low pressure. As areas clash, the rain comes down. The 6-day forecast inclusive of today forecasts modest to moderate rain with the possibility July 4 will wash out in the more densely populated Eastern corridor. My quick retail survey hints that the shelves are heavily stocked, but the barbeques may not be processing the inventory to the extent originally anticipated.
In the overall scheme of things, the weekend feasting does not make or break the cattle market. It does, however, set a tone as we move through July. If too much flesh is left in the stores, we will see weakness in the live that can spill over to the tight feeder market. Since feeders have the higher price, I ventured into the short October on the possibility of a more extended correction.
Sadly, some traditional markets like meats, lumber, and orange juice have become thin. This adds to intra-day and inter-day volatility. Pork bellies are almost untradable. The October feeders boast 424 volume and 2411 open interest. Thank heaven August still has liquidity!
Speaking About Weather
The USDA reported that corn and soybeans are in the fields in greater quantities that originally anticipated. At the same time, weather could not be more ideal. The combination adds to optimism over the 2004 harvest. Still, soybeans cannot overcome old crop pressure...yet. According to The Wall Street Journal, the Chicago Board of Trade predicts few, if any July deliveries in beans or products. This suggests there will not be a squeeze in the July contract.
Once again, I am tempted to sell July and buy November. This morning saw $2.34 difference as we move toward the July expiration. August is still old crop and it's $1.13 under July. I recall when May wheat was squeezed on delivery just before prices collapsed. That was a disaster, but highly unusual. The more common scenario is long liquidation just around first notice which was yesterday, June 30. So, we don't have a typical pattern from my perspective, hopes, and aspirations!
If July maintains strength through next week, the August/September should expand. This would be an interesting situation because there's a 94 cent spread between the "transition" deliveries. Given the early southeast and south central planting, new-crop beans should begin coming to market as early as late August...around the time of the August expiration. Question: Would you take delivery of August beans at $1 premium to cash?
Thus, an excellent spread opportunity is developing...particularly if crop progress accelerates through July. This year, podding will be one week to 10 days ahead of the curve. I believe this will place substantial pressure on August beans as we move toward expiration.
Taking a moment to backtrack, I pointed out that the price-to-cost ratio coupled with available acreage favored corn. Indeed, farmers took up corn over beans as the markets reflect. Picture perfect conditions have the potential to dump December corn below 2.40.
Yesterday's action appears as a breakaway gap with today's follow through. This leaves the January gap above 2.54 vulnerable. Consider the extended trading range from last June through January that was contained between 2.34 and 2.50. If that is our reference range, 2.40 is very realistic as a target for December corn.
Of course, I don't want to neglect our short July oats. Now that prices have busted below 1.39 support, we have the potential to test 1.22. I was looking for more dramatic action in July, but I fear we have limited our time. Still, with oats boasting the lowest margin, this move represents an excellent return.
We see the large asymmetrical descending triangle with multiple 1.39 supportive tests. We are now below contract lows. Again, the gap is encouraging.
So, the only confusion is over beans. What to do!? What to do!?
July 1, 2004
Philip Gotthelf
Commodity Futures Forecast
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