Trading in 2023: Navigating Commodity Price Volatility and Interest Rate Uncertainty
Two trading challenges for all types of firms are likely to persist from 2022 into 2023: commodity price volatility and interest rate uncertainty.
The collapse in natural gas prices at the end of 2022 (into 2023) has left many businesses with the question “To hedge, or not to hedge?”. Whilst energy markets have returned?to some kind of normality, we need to ask, “is this the calm before the next storm?”
The recent falls in commodity prices also make the direction of interest rates harder to predict and manage. Financial markets and Central Banks have divergent views on the pace and duration of interest rate rises, resulting in sharp market movements surrounding each major data release and Central Bank (CB) announcement.
The latest IMF World Economic Update states that “CB’s are making progress on inflation but need to keep raising rates above neutral, until there’s a decisive fall in underlying inflation”. Whereas financial markets are currently pricing in a lower peak and potential interest rate cuts towards the end of 2023. Liquidity and volatility extremes in the commodities markets, especially in the energy space, have continued from 2022 into early 2023 making hedging decisions highly challenging for businesses.
Firms would do well to remember that most market participants have no or limited experience of trading during a period of high inflation coupled with price volatility. So there are clear risks across all asset classes surrounding liquidity, volatility and lack of experience.
Indeed, market regulators have described the current state of markets as “fragile”. The IMF referenced “worsening Chinese Covid disruptions; a further Chinese property slowdown; an escalation of the war in Ukraine” as potential downside risks for 2023 or “known unknowns”.
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But what about the “unknown unknowns”?
Additionally, the extreme volatility of 2022 caused margins (collateral) on all Exchange traded derivatives to increase significantly. This, in turn, has led to lower market liquidity: a big challenge for traders and risk managers. Lower liquidities also raises questions for those in reporting and compliance roles – as a result of the different trading behaviours in this environment.
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