Volatility in the global commodities and markets is the name of the game in pandemic. The global commodity index today is double of what it was in March 2020. The index is at a 10-year high. Last time such levels were seen in 2011. The question is what is driving this momentum, how long will this continue and what is its impact on Pakistan.
There is no easy and straightforward answer as these are unprecedented times. Lately, both commodity prices and US bond yields have been heading north. This is counterintuitive as they usually move in the opposite directions. This one factor implies there is something wrong with this trend. The underlying reasons for this hike in commodity prices are of supply side and liquidity. There is no demand surge as such. Within global commodity index, around 50 percent weight is in oil, and oil related commodities. The world travel is not yet open. The demand expectations are building based on the vaccinated world.
The OPEC has not decided to end the oil production cut as demand resurgence is not in sight. Yet, the oil prices keep on heading north. It is the liquidity that is finding its way into the commodities – just like the case was in tech stocks last year. The latest stimulus announced by the Biden administration is further fueling the commodity prices.
Apart from liquidity, global supply chain disruptions are making some commodities crazy. The supply chain is yet to restore. There is high demand of some commodities and items (such as semiconductors) and disruption in supply of these and others including the supply cut in oil.
In the backdrop of growing commodity prices, inflation fears are building up. That is increasing the global bonds yields. The US treasury bonds yields are up – US 10-year bond hit a low of 0.52 in 2020 and now it is around 1.6 percent. Usually when the bond yields move up, the commodity prices move down; but now the increase in commodity prices is driving bond yields. It is a mix of supply and liquidity factors that is stirring the markets.
This all is bringing fears of slippage in current account, hike in inflation and expectations of interest rates hike in Pakistan. The country is largely import based, and any increase in commodity prices brings macro picture in the red. Add political uncertainty, the combination is enough to disturb stock market euphoria.
The problem is that inflation never came down in Pakistan. Inflationary expectations are positive in developed world today; but it is a hanging sword for Pakistan. The talks of interest rate hike are building up too. Now the question is when will tightening begin.
For that, the view on sustainability of high global commodity prices needs to be developed. The surge is due to supply disruptions and liquidity enhancement with no signs of demand to be higher than pre-COVID levels. This means that the sustainability of this high price is questionable.
Seeing this, based on SBP forward guidance, latest inflation numbers, and global central banks views, it seems SBP will hold it horses in March. But increase in May by 50-100 bps seems inevitable. The market rates have already adjusted upwards – 6M Kibor at 7.7 percent (policy rate at 7%) and 10Y paper secondary yield at 10.32 percent.
Thus 50 bps increase is already priced in. If the global commodity prices remain high till May, nothing less than 100 bps would cut. If these started reverting, 50 bps might be the case.
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