The Interest Rate Cut Cycle Begins: What is the Impact on Commodities?

The Federal Reserve cut the federal funds rate by 50 basis points, bringing it down to 4.75%-5.00%, exceeding market expectations. This marks the Fed's first rate cut in four years. According to the policy statement, inflation has made progress towards the 2% target but remains "slightly elevated." The risks to both employment and inflation are balanced. Additionally, the Fed's dot plot suggests another 50-basis-point cut is likely this year. Historically, the Fed rarely begins a rate-cutting cycle with such a large adjustment.

Looking back over the past 20 years, the Fed has raised rates three times and cut rates twice. Yesterday's 50-basis-point cut is the third in this cycle. Typically, when the Fed starts a rate-cut cycle, it often coincides with a significant recession. The larger-than-expected cut has increased concerns about the worsening economic outlook, leading to a mixed performance in commodities, with increased market divergence rather than a rally.

Historically, commodities often experience a short-term rise at the start of a rate-cutting cycle, especially during "preemptive cuts" like this one. However, if the preemptive cuts fail to counteract economic downturns, the Fed might shift to more aggressive "crisis cuts." These cycles tend to be shorter and deeper, leading to a more significant decline in commodity prices.

The market remains cautious about pricing in a "recession" or "hard landing." While the rate cut offers short-term support for commodities, it is not a guarantee of economic recovery, and achieving a soft landing in the U.S. economy remains challenging. Aside from assets like gold, which have clearer investment value, other assets should be approached with caution.

Impact on Commodity Sectors

Energy and Chemical Sector

As the Federal Reserve enters a rate-cutting cycle, commodities are like boats rising with the tide of increased liquidity. Overall, the Federal Reserve’s rate cuts are favorable for chemical prices. There are three key ways this impacts the chemical market:

Increased Dollar Supply: A Federal Reserve rate cut signifies an increase in dollar supply. Since many international chemical products are priced in dollars, an increase in dollar supply supports price growth.

Weaker Dollar: A rate cut suppresses the dollar’s value, making the currency cheaper relative to others. This weakens the dollar index, which is inversely correlated with commodity prices, thus driving prices up.

Stimulated Economic Growth: The rate cut stimulates economic activity, which correlates positively with demand for commodities. As demand grows alongside economic recovery, chemical prices rise.

Within the industrial chain, the impact of rate cuts diminishes as we move down from raw materials to finished products. The effect is most significant on crude oil, which is sensitive to U.S. monetary policy. However, moving further down the chain to products like PVC, glass, and soda ash, the impact weakens.

Early feedback suggests that while the 50-basis-point rate cut exceeded expectations, it has not significantly boosted confidence in the energy and chemical markets. Some products continued to decline in price. Even the oil sector has shown little positive reaction. The energy and chemical markets remain mired in struggles caused by weak demand and overproduction.

Non-ferrous Metals Sector

The non-ferrous metals sector did not show a dramatic response to the recent Federal Reserve rate cut. This is largely because investors had already anticipated the cut, leading to an increase in the sector’s valuation in the days leading up to the announcement. As a result, after the rate cut was implemented, the market experienced a "sell the news" scenario, where the positive impact had already been priced in.

Federal Reserve Chair Jerome Powell's comments following the rate decision will likely guide the future trajectory of the non-ferrous metals market. He emphasized that the Federal Reserve is not in a rush and that continued 50-basis-point rate cuts should not be considered the new norm. He also noted that weak employment data might be a reflection of the slowdown in economic growth.

While the rate cut did lower the dollar index, which typically boosts non-ferrous metal prices, concerns about the broader economy temper expectations for a significant upward trend in these prices. Moving forward, the market for non-ferrous metals may continue to trend upwards slightly, but with volatility. If the economic growth expected during the "Golden September and Silver October" period and the fourth quarter materializes, and if supply remains limited and inventory levels decline, the non-ferrous metals market could experience a mild supply-demand imbalance, offering some upward pressure on prices.

Ferrous Metals Sector

For the ferrous metals sector, the impact of this rate cut appears limited. The market had already priced in the expectations beforehand, suggesting the potential for diminishing positive effects. The Federal Reserve's larger-than-expected rate cut might open the door for more room in China's monetary policy, with a corresponding 10-basis-point rate cut expected domestically. However, the effectiveness of China's monetary policy on economic growth is waning, and room for further rate cuts is shrinking. Both corporations and households are opting to deleverage rather than expand credit under lower interest rates, and the commercial banking sector's net interest margins also limit the room for further cuts.

With insufficient internal drivers, the market now looks more toward fiscal policy measures for stimulation. It is anticipated that trading in the ferrous metals market will shift back to fundamentals. Currently, steel is still in a de-stocking phase, with some improvement in fundamentals, but the high raw material inventories are compressing the premium on overvalued assets. Confidence in industrial purchases remains weak, limiting the price's upward momentum. Rebar inventories have rapidly declined, with total inventories dropping below 5 million tons, the lowest in nearly 10 years, even causing supply shortages in some regions. Meanwhile, iron ore continues to accumulate stockpiles, with no significant reduction in shipments from non-mainstream mines, driving prices further downward. In the near term, steel prices are likely to remain stronger than raw material prices, but a stabilization of raw material prices will require marginal production cuts from high-cost mines, which will take time. Even after prices stabilize, a large upward move is unlikely due to a lack of new demand drivers, long-term overcapacity in the industry, and weak macroeconomic forces in China.

Agricultural Products Sector

The impact of the Federal Reserve's rate cut on agricultural products is more complex. Historically, a Fed rate cut has tended to weaken commodities overall, but the effect varies greatly depending on the specific product. In the short term, a rate cut could stimulate a rise in agricultural product prices, particularly for imported goods into China. However, concerns over a potential U.S. economic recession could also temper the market's response. Products with lower prices and supply-side reductions, such as sugar, oils, and oilseeds, may see a rebound, while other crops could experience limited price increases, especially as the northern hemisphere's harvest season brings disruptions to a close. In a backdrop of weak demand, the price-boosting potential for crops with fewer supply disruptions remains modest.