US dollar is getting stronger on interest rate expectations
In the week ending November 20, the strong dollar was one of the main factors behind the decline of base metals. The weak Chinese economic data and demand concerns along with the strong dollar resulted in multiyear lows for base metals last week.
The US dollar and base metals share an inverse relationship. The increasing strength of the US dollar will make the commodities that are trading in dollars expensive. The graph above shows the inverse relationship between the US dollar and LME (London Metal Exchange) 3M copper for the last month. The US dollar ended the week stronger at its highest level since April. The increasing expectation of an interest rate hike in December is one of the main reasons behind the strength of the US dollar.
Possibility of an interest rate hike
The timing of the Fed’s interest rate decision has been one of the main discussions in 2015. Earlier this month, Fed chair Janet Yellen said that there is a possibility of an interest rate hike in December if the US economic data remains on track. This made investors’ anticipation of an interest rate hike in December skyrocket, which has supported the US dollar in November so far. According to notes from the Federal Open Market Committee, members felt that conditions for an interest rate hike could be met by December.
If the Fed does raise interest rates in December, the US dollar will become even stronger. This would bring down the base metal prices to much lower levels than in the week ending on November 20. A rate hike would also bring down base metal mining companies like Freeport-McMoRan (FCX), Glencore (GLNCY), Alcoa (AA), Rio Tinto (RIO), and also base metal ETFs like the PowerShares DB Base Metals Fund (DBB) and the SPDR S&P Metals & Mining ETF (XME).