Dec 22

Coffee Weekly Report - 2023 12 22

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  • The market's path to full carry is intertwined with historical trends, inflation dynamics, public debt, and real rates, shaping its evolving landscape.

  • The emergence of the Brazilian 24/25 scenario introduces complexity, with recent weather issues providing a contrast to the medium run potential pressure derived from debt issuance impacts on yields.

  • Still, while yields signal a bearish outlook in the medium term, an immediate downward impact on the Dollar Index provides crucial short-term support.

  • Navigating this intricate terrain demands a nuanced understanding, emphasizing adaptability to regional dynamics and global indicators. Market participants must remain vigilant to capitalize on emerging opportunities and mitigate risks in this multifaceted environment.

Front-month inversion: macroeconomic factors

The prospect of the market returning to full carry hinges on a multifaceted analysis that considers historical trends and the current macroeconomic context.

Delving into the data from 2002 to 2023, the market last experienced average carry in early 2020, marked by a 9% figure derived by subtracting the first contract from the sixth contract.Understanding this historical perspective is crucial for gauging the potential trajectory of the market.

A pivotal aspect of this analysis is the impact of inflation dynamics on market behavior. Notably, U.S. inflation, which soared to a 20-year high of 9.1% in 2022, has since exhibited a downward trend.

This deceleration in inflation rates prompts a recalibration of expectations regarding the Fed Funds Rate. Projections now point to lower rates persisting throughout 2024.

The inverse relationship between inflation and market dynamics becomes evident as the specter of inflation recedes.

Figure 1: United States Inflation Rate (%)

Source: Refinitiv

Figure 2: Fed Funds Rate Curve (%)

Source: Refinitiv

However, a significant short-term obstacle on the horizon relates to the burgeoning public debt and its repercussions on commodity markets. The U.S. Treasury Department, in its perennial quest to minimize the long-term cost of U.S. debt, resorts to issuing short-term debt instruments, such as T-bills, during periods of elevated interest rates.

Even if interest rates undergo a reduction in the upcoming year, the persistently high public deficit will likely demand continued debt issuance. This, in turn, amplifies the overall debt burden on the country, potentially requiring higher market premiums.

Shifting the focus to the realm of real rates, an examination of spreads reveals a nuanced perspective. Presently, the inversion of spreads is not likely. Drawing on historical correlations, the NY arabica coffee carry has shown a positive relationship with U.S. yields.

However, the delicate balance between debt financing and inflation control introduces complexities. Fundamentals emerge as a dominant factor, emphasizing the intricate interplay of economic forces.

Figure 3: Federal Debt by Type Versus Federal Fund Target Rate

Source: U.S. Departament of Treasury

Figure 4: NY Arabica 6th Contract – 1st Contract vs. Real US Interest Rate

Source: ICE, Refinitiv, Fred Data

In Summary

In conclusion, the market's journey back to full carry is intricately tied to a confluence of factors. Historical trends, inflation dynamics, public debt considerations, and real rates all contribute to the evolving landscape.

Navigating this complex terrain requires a nuanced understanding of the intricate relationships shaping the market – which, while the Brazilian 24/25 takes shape, will hold a stronger influence over prices.

Yields themselves are a bearish point, especially in the medium run, but in the short run, the immediate downward impact on the Dollar Index provides support.

Weekly Report — Coffee

Written by Natália Gandolphi
Reviewed by Alef Dias


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