The uncertainty over the long-awaited US federal funds interest rate hike finally ended when the Federal Reserve raised rates by 25 basis points on December 14, 2016. According to the dot plot, the Fed foresees three rate hikes in 2017. This is in contrast to the previous dot plot, which implied two rate hikes for 2017.
Impact on copper prices
One possible repercussion of the Fed’s rate hike could be the further appreciation of the US dollar. Copper is no different than other commodities that have a negative correlation to the dollar. Further strengthening of the US dollar could negatively impact copper prices (DBB).
A huge amount of copper in China is believed to be tied to carry trades. In a typical carry trade, importers in China open an LC (letter of credit) with foreign banks by paying a portion of the total import costs. Chinese importers then sell the copper and get cash.
The typical payment time for an LC is three to six months. In this way, Chinese importers get access to cheap US dollar funds. The basic premise behind these deals is the arbitrage between interest rates in China and the developed world.
Copper’s financial demand
As the differential between US and Chinese interest rates is expected to narrow following the rate hike, we could see some unwinding in copper carry trades. This could impact copper’s financial demand. The unwinding of copper financing deals could increase copper’s supply as some of the metal tied up in these financing deals could enter physical markets. Notably, one of the factors supporting copper prices has been lower-than-expected supply growth.
We’ll look at copper’s 2017 demand-supply equation later in this series. In the next article, we’ll see why Freeport-McMoRan’s profitability could be impacted by rising interest rates.