Dollar trend to be key factor for commodities as Fed's rate tightening debate intensifies

Commodities saw another strong weekly finish indicating that the buyers have re-entered after a brief break earlier this month. Weakness in the US dollar index, improved risk sentiment and supply issues have lent support to commodities.

We saw a rally across commodities indicating broad-based buying, however, there were few highlights. Gold breached the pivotal $1,800 per troy ounce level and tested 1-month high; Zinc zoomed to 2-month high while copper topped $8,000 per tonne level; crude oil recovered more than 9 percent from February lows set late last month.

The US dollar index slumped to six-week low amid increasing debate about Fed’s monetary policy. Improved risk sentiment also reduced its safe haven appeal.

The Fed’s meeting by meeting approach has caused uncertainty in the market and market players are looking at US economic numbers and central bank comments to gauge the central bank’s next move.

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The key event for the week was inflation data. US consumer price rose 8.5 percent on the year in July as against market expectations of 8.7 percent growth. US producer price rose 9.8 percent on the year in July as against forecast of 10.4 percent growth.

The CPI and PPI data for the US showed smaller-than-expected growth indicating easing price pressure. With signs of improvement in inflation situation, market players became hopeful that the Fed may slow down the pace of interest rate hikes and this pressurized the US dollar and pushed riskier assets higher.

Fed’s tightening debate however continued as most Fed officials maintained a hawkish stance. Fed officials believe that inflation level is still too high and the central bank may need to continue with rate hikes.

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While weakness in the US dollar kept commodities at large supported, some commodities also benefitted from supply side issues. Industrial metals are supported by concerns that energy crisis in Europe due to reduced supply from Russia may hamper production activity. Crude oil also edged up as International Energy Agency, in its monthly report, warned that Russia’s oil output is set to fall roughly 20 percent by the start of next year as a EU import ban comes into force.

While buyers focused on weaker US dollar and increasing supply risks, demand concerns continue to linger. Mixed economic data from major economies highlights increasing challenges while China continues to struggle to get the virus spread under control. Further denting outlook for Chinese economy, People’s Bank of China said it will safeguard the economy against inflation threats, pledging to avoid massive stimulus and excessive money printing to spur growth.

Trend in the US dollar may continue to be key price determining factor for commodities as market players try to assess Fed’s next move. Further cues may come from minutes of Fed’s July meeting which will be released next week. If FOMC minutes reaffirms the hawkish stance taken by most officials, we may see some stability in the US dollar which may bring a halt to current rally in commodities.

Commodities may also get affected by Chinese economic data as it will reflect upon health of the economy. China’s industrial production and retail sales data is due in the coming week and early forecasts indicate some improvement in activity last month.

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