HR futures: Forward premiums remain substantial. Are they substantial enough?

It’s been more of a stop to the bleeding rather than a reversal for now on the index. But since our last report, weakness in futures is pretty modest. Month over month it looks like this:

While we had hit lower lows than the above in the interim (October actually got as low as $723/ton on July 23^rd), it has hardly been a brutal rout of the bulls here. Spot prices are down about the same amount as the futures above. And while this is usually a momentum market, we still see September and beyond pricing in nearly a $100/ton premium to most spot offers available (or more depending on the particulars). This in turn prompts a lot of questions yet again about how much premium needs to be baked into the forward price in order to get physical inventory holders to sell futures.

All eyes on interest rates

The answer is more art than science, and there are a number of obvious moving pieces (liquidity, access to credit and cost of credit, storage costs, etc.). Some of them can vary substantially from one entity to the next. But we still think the relevance of interest rates here is high. An imminent rate cut would likely be positive for underlying fundamentals. It would also the ease the financing costs and make a higher premium less necessary for carry traders.

Little has changed in those carries as the number is in line with where it was a month ago. The market is paying about $150/ton to hold HR until December. As far as how attractive that level has been to sellers, naturally the interest varies. But the relatively low exchange volumes might be implying that the number of “risk off” pessimists carrying inventory in HRC is not a tremendously high number – or we might expect to see more volume at these levels. Certainly, the continued optimism about trade protectionism, especially in an election year, is a factor.

Higher interest rates are a factor. And yet it’s hard to shake the feeling that part of the contango in this market is simply based on the assumption that we do not have a lot of downside room here in the spot price unless there is significant economic contraction imminent.

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