Tit-for-Tat Sanctions by U.S. and China Weigh on Commodity Prices

(Bloomberg View) -- The prices of industrial metals, oil and other commodities have risen significantly since the Chinese manufacturing recession ended in June 2016. But many have fallen from their highs in January 2018, first in reaction to the risk of higher interest rates and now, more critically, because of trade tensions and the potential for global manufacturing and growth to be slower than expected.

The potential for slower growth due to U.S. and reciprocal tariffs was highlighted by the International Monetary Fund in early March. In addition, the March Chinese Caixin and U.S. ISM manufacturing data showed sharp decelerations -- and that was before the announcement on Sunday that Chinese tariffs on 128 U.S. goods would take effect Monday. The potential for tariffs to slow growth was confirmed on Monday as U.S. stocks experienced one of their worst selloffs of the year.

The Caixin purchasing manager index is the most critical data point for the health of Chinese manufacturing and growth, because it is privately compiled and is a survey of small and medium-sized manufacturers. For March, the index fell from 51.6 to 51.0. Although still expansionary, this was the lowest reading of the index since November 2017 -- and it was the biggest monthly drop since September 2017.

The big problem for commodity prices is that this index was expected to rise. The drop presents downside risks to industrial metals prices in the near term, because a surprise deceleration in purchasing orders from manufacturers means that the level of expected demand for metals won't be there. This weak data point by itself could keep copper, aluminum, nickel, tin and other metals in choppy to bearish trading patterns.

In the wake of the drop in the Caixin late April 1, the March U.S. ISM Manufacturing Index also fell sharply Monday morning, to 59.3 from 60.8. Although the ISM remained relatively strong, this was still the lowest reading since December 2017 and represented the biggest monthly drop since October 2017. The question now is: Are the declines in the March 2018 Chinese Caixin and the ISM just the beginning for global manufacturing? It's likely.

After all, the March slowdown in global manufacturing has been influenced by fundamental trade concerns that have just emerged and that could worsen. Plus, U.S. companies are facing inflationary pressures from a tight labor market and higher interest rates. This means that commodity prices could come under further pressure.

Whatever happens next with trade will affect many financial markets, and one of the most exposed will be industrial metals. The U.S. tariffs that were announced on steel and aluminum as a national security measure in early March have inadvertently depressed global aluminum prices, which recently fell to the lowest levels since August 2017. But those tariffs have also weighed on copper, lead, zinc, tin, palladium and other metals.

When it comes to China, aluminum is the most critical metal to watch, because that country consumes a majority of the world's output. For aluminum, technical traders would recognize that prices are below critical 30-day and 100-day moving averages, and prices have recently seen a triple top. This means that bearish technicals are piling on to a fundamentally bearish set of trade policies. And trading patterns of aluminum often have forward-looking implications for future Chinese manufacturing, growth, as well as demand and prices for other industrial metals. In recent years, aluminum prices have also often led crude oil prices.

Given the escalating risks of additional reciprocal tariffs and an all-out trade war between the U.S. and China, as well as the slowdown in the critical March U.S. and Chinese purchasing manager indexes, industrial commodity prices face additional downside risks. Some have argued that the risks of a trade war are overblown. Federal Reserve Chairman Jay Powell said March 21 that trade was not part of the Federal Open Market Committee's quarterly forecasts of growth, inflation, or future interest rates. “We don't do trade policy here at the Fed,” he said.

Unfortunately, the economy does “do trade,” and this is where some downside risks to growth have been introduced, but remain only partially priced into equity markets and industrial commodity prices.

The potential for slower global growth presents further downside risks to industrial metals prices, even as global growth has been strong, and prices had just recently seemed poised to rise. Now, the outlook is more bearish.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jason Schenker is president and founder at Prestige Economics LLC.

To contact the author of this story: Jason Schenker at jasonschenker@prestigeeconomics.com.

To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.

©2018 Bloomberg L.P.