by Jack Timlin (Macro, Bonds and Commodities Analyst)
The last two years have seen multiple extreme and rare events occur: The Covid pandemic and recovery – during which the US printed nearly 80 percent of all US dollars – the global economy is currently suffering from various supply-side issues, almost double digit inflation rates and commodities with record price levels. We are in a historical macroeconomic context, and as such, 2022 and 2023 are likely to be very different to that of recent years.
Brent Crude Oil prices recently surpassed their previous 8-year high, hitting $100 per barrel for the first time since 2014, and there are multiple reasons to believe prices will continue to climb throughout the year. The graph below shows the recent breakout past the trend line, with prices currently at $98.22 per barrel. There are many causes for the price movement that are likely to persist throughout 2022: since January, multiple oil-abundant countries have been struggling with supply issues, such as Kazakhstan experiencing fuel protests and Libya suffering from supply outages disrupting supply chains.
More notably, there is the Ukraine crisis, with Russia recently launching a full-scale invasion. The graph below shows how Russia produces 11 percent of global oil supplies, and exports 21 percent of the EU’s total oil consumption. The extent of which oil prices climb largely depends on the severity of the war, and on the responses NATO and the EU have – a long, devastating war crippling Ukrainian infrastructure, and severe sanctions on Russian oil, could potentially send oil to over $125 per barrel, according to JP Morgan.
The chart below shows that the US 10-year treasury yield rate is oscillating around two percent, up from a low of 1.1 percent in 2021. This is largely because of investors selling their bonds amid inflation fears – US inflation has consistently exceeded expectations, with CPI currently at 7.5 percent. Central banks are becoming increasingly worried about rises in prices, with the UK already increasing rates to 0.5 percent. In the US, JP Morgan forecasts nine 50 bps interest rate hikes through 2022, rather than one large increase.
This is important for the commodities market as it tends to be one of the asset classes that is most positively correlated with inflation. We therefore expect all types of commodities to continue rallying in 2022 and the current momentum to sustain, at least in the short term. Additionally, Russia and Ukraine are big suppliers of many raw materials, and the geopolitical tensions support our view on commodities. For instance, the two are responsible for over 25 percent global exports of wheat. Due to the war, wheat futures prices have risen sharply amid fears over supply-chain problems – prices are up 15 percent so far this year.
Finally, it is worth talking about Gold as the precious metal has underperformed in the last two years. However, it still remains one of the best inflation hedges and we expect it to outperform as the market continues to price inflation. Historically, it soars when markets tank, and we believe it remains one of the best hedges for the uncertainty surrounding geopolitical tensions.