Volume Proxy turns negative amid US Fed hike, oil slump

After a buoyant start to the year, the global chemical market is due for a pause. The recent sharp decline in crude oil values has put a halt to the big run-up in many chemical and polymers prices.

Plus, the US Federal Reserve’s quarter-point hike in interest rates on 15 March – following the same in December 2016 – serves as a reminder that the era of easy money, typically a boon for commodities of all sorts, is likely over.

The US equity market, including chemical stocks, took the widely anticipated interest rate hike in stride with gains across the board. It was a relief rally as many feared a more hawkish tone from the Fed. The Fed is indicating two more quarter-point rate hikes this year, followed by three more in 2018 in a long-term effort to finally normalise interest rates.

There has been widespread strength in the global manufacturing sector, evidenced by robust readings of the US and Eurozone manufacturing PMIs (purchasing managers’ indexes).

The China manufacturing PMI has lagged but is still indicating expansion.

Moderately expanding economic activity, as well as inflation rising towards the Fed’s 2% target, were cited by Fed chair Janet Yellen justifying the rate hike and outlook for further increases.

“The simple message is the economy is doing well,” said Yellen at the Fed’s press conference.

“We have confidence in the robustness of the economy and its resilience to shocks.”

Across the pond, the European Central Bank (ECB) has yet to show such an inclination to raise interest rates despite stronger economic figures – thus the US dollar strength versus the euro.

VOLUME PROXY TURNS SOUTH

One sign pointing to short-term weakness in chemical volumes is the Volume Proxy, developed by Paul Satchell, chemicals equity analyst for Investec.

This leading indicator tracks changes in chemical and polymer spot prices on a weekly basis to get an idea of volume trends.

While most chemicals trade is conducted on a contract basis, changes in overall demand have a leveraged impact on spot demand, and thus spot prices.

After 13 consecutive weeks in neutral or positive territory, the Volume Proxy has turned nominally negative (-2) on an aggregate basis with geographic weakness in Asia, and product weakness in aromatics and intermediates.

“Importantly, this softening trend began before the recent dramatic fall in oil prices. Given the current state of oil price expectations, with the consequent likely impact on chemicals purchasers (tactical destocking), we expect Q1 2017, though reasonably solid overall, to end on a downtrend,” said Satchell.

The analyst anticipates “at least a pause in the general trend of improving confidence in basic chemicals, which we would expect to be apparent 
in outlook statements during the Q1 2017 results 
season”.

The trend bears watching. But with the US Fed in tightening mode along with greater uncertainty around policy reforms in the country, crude oil having pulled back, a choppy manufacturing recovery in China and key upcoming elections in Europe, a level of caution – which had been relaxed in past months as Satchell pointed out – is warranted.