China Dragging Commodities Down
The downward revision to China’s leading economic index has weighed significantly on equity and commodity markets this morning. The conference board claimed that the index rose by only 0.3% in April, marking a significant downward revision from the 1.7% released earlier this month. This ties in well with several of Business Monitor’s views; a relatively bearish China growth view, a cautious view with regard to cyclical commodities such as energy and metals as well as a bearish view with regard to the dry bulk sector.
- The technical picture across equity and commodity markets continues to look weak, while bond markets are increasingly bullish.
- Global economic fundamentals will continue to weaken in H210, with downside risks.
- Combined, these dynamics could signal a trend reversal, particularly if key commodity markets fail to push above their 50-and 200-day moving averages in coming weeks.
Equity markets are weaker this morning on the back of the revision to China’s leading indicator, with Asian markets down sharply, and US markets likely to follow when they open. As my colleagues at Business Monitor have been flagging up, the short-term rally in US equities has been running out of steam. The dow failed to break above the 50-day moving average, and is currently trading below its 200-day moving average. Furthermore, momentum indicators look weak, with the MACD turning lower (crossing the signal line) below the zero line. As such, I do not rule out a break below trendline support around the 10,000 level, which would be a bearish technical signal. Moreover, fixed income markets have seen yields compress across the curve, which suggests that bond markets are pricing in a sustained period of weak economic growth and possibly deflation. In particular, I highlight the Australian 10-Year government bond, the yield on which has collapsed to 5.14% from 5.40% in recent weeks. This is of particular importance given the strong trade links between China and commodity exporters such as Australia, Brazil, Canada and Russia to name but a few, which have been the main beneficiaries of the reflation of commodity prices since March 2009.
Moreover, the dry bulk shipping sector and hence the Baltic Dry Index is suffering from the twin forces of falling demand and an oversupply of ships which looks set to come to a head in H210. From a demand perspective, the major concern for ship owners has been a notable retrenchment in Chinese imports of the two main materials involved in steel production – iron ore and coking coal – which fell in both April and May on the back of retreating demand from the country’s property and construction sectors.
At the risk of sounding like a broken record, I continue to highlight that commodities such as energy and metals will be most affected by falling equity markets and slower growth in China. As such, I anticipate sideways trade for energy markets, with risks of a downside break. From a technical perspective, front-month Brent Crude is struggling to push above its moving averages, and this could see a move back to trendline support around the US$70.00/bbl area, particularly if the number of miles driven in the current US driving season surprises on the downside. Furthermore, in the event of a large correction, this would likely see the MACD turn lower back into negative territory which would be bearish.