⚠️Automatic translation pending review by an economist.
The narrowing ofthe output gap in the United States and China, i.e., the difference between actual and potential economic activity, and a resurgence in inflation expectations would contribute to a positive cyclical phase for commodity prices. High expectations for an agreement among OPEC-affiliated oil producers would imply (1) a sufficient reduction in supply and (2) a stabilization of inventories, sufficient to fill the demand gap in the market and stabilize the price per barrel at around $50.
These two events remind us that commodity prices are linked to phases of economic growth but also to the relationship between supply and demand.
The cyclical nature of commodities can be explained by the slow response of production supply to price changes over a period of less than 4-6 months in the best-case scenario. Thus, in a downturn, supply maintains production despite weaker demand, which contributes to the accumulation of inventories. Prices fall. In an upturn, the resurgence in demand is met by the depletion of inventories until the production apparatus reacts to the cyclical trend. Prices rise on the basis of demand exceeding production capacity. It is possible that the current environment corresponds to an inflection point in the cycle where the recovery in activity is not immediately accompanied by a rise in prices. To this end, a reduction in OPEC supply would be likely to accelerate the effects of activity on the market price of raw materials.
The effect of a possible rise in commodity prices is particularly important for all emerging countries. On the one hand, rising commodity prices are positively correlated with the accumulation of savings in emerging countries, which, when transformed into global liquidity, supports financial asset prices and reduces debt costs by improving financial conditions.
On the other hand, while the relationship with the US dollar has historically been inverse, the correlation between oil prices and the US currency has become positive in recent weeks. The negative effect of US dollar fluctuations on emerging markets (increase in USD debt stock, rise in imported inflation) could be offset by the positive effect of higher commodity prices (trade surplus, improvement in public finances).
More broadly, the effect of higher commodity prices would favor financial conditions globally. One analysis could be that low energy prices limit inflation and the potential reaction of a central bank to raise its key rates and thus tighten financial conditions. However, this effect is more than offset by the rise in credit spreads. This event, which occurred in 2015 and early 2016, increased the risk of default, particularly in the high-yield bond segment, which is less liquid and more exposed to defaults in the energy sector. China avoided a soft patch (slowdown) in its economic growth through reforms targeting the supply side of the sectors with the highest credit risks (real estate, construction, local authorities). Margins in the real estate sector increased thanks to the relaxation of the criteria required to obtain a mortgage. Rising real estate prices have increased the wealth of indebted homeowners, thereby reducing the risk of default. Margins in the construction sector have also been boosted by the elimination of various production capacities. Overall, this has increased the rate of return for these companies and reduced their non-performing loans. Financial conditions, which are conducive to growth, have thus improved.
A rise in oil prices would therefore have three advantages. ( 1) A decline in risk premiums on low-rated bond segments, thereby improving financial conditions; (2) A stronger upturn in savings, which would in turn fuel a further rise in oil prices; and (3) A faster normalization of Fed Fund rates in response to a resurgence of inflation linked to higher energy prices and the appreciation of the US dollar following the increase in trade in commodities denominated in that currency. This normalization would avoid further debate about the liquidity trap in the event of another economic recession. But a dollar that is positively correlated with oil prices, as is currently the case, would remain a surprise. This is one of the major bets that strategists will have to position themselves on in 2017.
