Commodity prices go haywire, raising fears of a coming financial crisis

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The prices of raw materials including oil CL00,
+0.63%,
wheat W00,
-0.32%
and palladium PA00,
+1.36%
surged this year as much of the global economy sheds COVID-related restrictions and Russia’s invasion of Ukraine led to a commodity-exporting region being cut off from the rest of the world.

This volatility has not only helped fuel inflation levels not seen in 40 years – market watchers warn it could jeopardize the stability of the global economy unless regulators and central banks do become aware of the threats posed.

See also: Corn futures climb to their highest prices in nearly a decade

“One after another, Ukraine-related developments expose longstanding flaws in the increasingly outdated framework of global trade and financial regulation after World War II,” said Karen Petrou, Managing Partner of the financial policy think tank Federal Financial Analytics, to MarketWatch. .

Petrou argued that rapidly rising commodity prices are putting pressure on both commodity traders and the banks and other actors who finance them, and that failure to properly regulate these entities could force the Federal Reserve to bail them out, a move that threatens popular backlash.

In the aftermath of the financial crisis, regulators debated whether to designate major commodity traders like Glencore, Trafigura and Archers-Daniels-Midland Co. ADM,
+0.13%
as systemically important financial institutions, which would subject them to greater regulatory scrutiny, “but they didn’t have the guts to go for it,” Petrou said.

Recent volatility also underscores the relationship between inflation and financial stability, according to Zoltan Pozsar, global head of short-term interest rate strategy at Credit Suisse.

“Central banks are in love with this idea that they control price stability,” he said in a phone interview. “I find it shocking that entities as crucial to price stability as [commodities traders]are not more closely monitored by the Fed.

Read more: Commodity trading firms face strain, but are they ‘too big to fail’?

Pozsar argued that the war in Ukraine will be a turning point in financial history that will catalyze a partial reversal of globalization and usher in a new monetary order based on commodity prices rather than the US dollar. In such a world, the Fed and its foreign counterparts cannot ignore the central role played by commodity traders.

“These are the entities that transport the commodities that you need for industrial activity and price stability,” he said. “A commodity trader guarantees price stability, not central banks.”

Regulators are taking note of these dynamics, even if they are not yet acting on them. The International Monetary Fund warned on Tuesday of “serious pressures on commodity financing and derivatives markets” in its biannual Global Financial Stability Report, following news earlier this month that the American Financial Stability Board was informed by the Commodity Futures Trading Commission and the Federal Reserve on the impact of commodity markets on financial stability.

Ramit Singh, deputy director for monetary and capital markets at the IMF, told a news conference on Tuesday that now was “probably the right time” for regulators to study the commodities space to identify gaps in the regulation of commodity markets.

Dennis Kelleher, president and CEO of the nonpartisan financial reform organization Better Markets, told MarketWatch that there are steps the CFTC could take to stabilize commodity markets, such as enforcing stricter position limits on commodity derivatives transactions, which would both lower commodity prices and reduce the risk of financial contagion.

A position limit is a control on the number of contracts an entity can hold at any given time, in order to avoid excessive speculation and volatility in commodity markets. The CFTC passed new position limit rules in 2020, as required by the 2010 Dodd Frank Financial Reform Act, but critics, including Current CFTC Chairman Rostim Benham said these rules don’t go far enough.

“Commodity speculation is largely unregulated because there are no position limits, or the limits are so high they don’t make sense,” Kelleher said. “These issues are linked. On the inflation front, instead of adopting position limits that work, which would bring the bid and ask prices closer together, we have big banks advising their clients to move more from their portfolios to commodities as a so-called hedge against inflation.

The CFTC declined to comment for this story.

Whether or not regulators decide to change policy in the face of rising volatility, Credit Suisse’s Pozsar argued that Americans should prepare for a world in which key commodity markets become a space for geopolitical competition.

This likely means that commodity prices will remain a major driver of inflation going forward, and if the global economy faces another systemic crisis, commodities will be at the center of it.

“That’s the definition of systemically important,” Pozsar said of commodity traders. “Just as Lehman moved bonds and cash until it didn’t, these companies are moving commodities until they didn’t.”

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