Mini-cycling
Substack Post Week August 03-07
For this week, the oil market provides a useful starting point because it shows the distinction between a temporary price shock and a structural change in demand. The possibility of an agreement involving Iran has pushed the front end of the WTI futures curve lower as traders price the prospect of additional supply and reduced geopolitical risk. Yet the reaction further out the curve has been considerably more limited. That divergence matters. If the dominant concern were simply an improvement in physical supply, the entire curve would be expected to adjust more consistently. Instead, the market is differentiating between a near-term supply development and a longer-term demand problem. The front end is responding to geopolitics. The back end continues to reflect uncertainty about how much oil the global economy will actually consume.
Iron ore offers a less ambiguous signal because its price is much more directly connected to industrial activity. Prices have fallen to multi-year lows as Chinese steel margins deteriorate and manufacturing momentum weakens. China remains the world’s dominant consumer of steel and one of the most important sources of incremental commodity demand. Weak iron ore prices therefore represent more than a problem for mining companies. They are a market-based indication that the industrial engine that supported global commodity demand for much of the past two decades is struggling to generate the same momentum.
This is particularly important because China’s weakness is no longer adequately described as a temporary property downturn. Property investment remains depressed, domestic consumption is weak, while economic activity has become concentrated in selected technology and export sectors. Those sectors can produce impressive headline growth without necessarily generating the broad-based domestic demand required to absorb China’s enormous productive capacity. The result is an economy capable of maintaining output in specific areas while simultaneously exerting downward pressure on global commodity prices.
The same distinction between production capacity and effective demand is visible in the United States. McDonald’s, for example, can report sales growth while customer traffic declines because higher average spending compensates for fewer transactions. That is not the same thing as healthy consumer demand. It indicates that households are becoming more selective, spending more per transaction where necessary while reducing the frequency or volume of consumption. Whirlpool is experiencing a similar dynamic at the other end of the spectrum. Large purchases such as appliances can be postponed when households become less confident about future income or financing conditions.
These developments become more significant when combined with the labor market data. The June JOLTS report showed weak hiring, declining job openings, persistently low quits, and net labor turnover around zero. Companies are therefore not necessarily engaging in mass layoffs; instead, they are becoming increasingly reluctant to add workers. That distinction is crucial. A labor market can appear stable when existing employees remain employed while simultaneously deteriorating because firms stop hiring new workers.
