Market Matters Blog

Fed Wants Banks Out of Commodities

The Federal Reserve stepped back into the spotlight Friday, two days after announcing it was leaving interest rates unchanged in September. However, its latest move could possibly be read as an attempt to limit banks' exposure to increasingly volatile commodity markets if a December rate increase -- particularly if it is larger than the expected 1/4% -- is seen.

According to a Wall Street Journal article, the proposals are to "minimize risks an environmental catastrophe could pose on the financial institution." The article goes on to point out such risks include "an oil spill, mine explosion, or power-plant meltdown at a bank-owned facility."

But the timing and reaction of markets following the release of the news would suggest there may be more to it than that. Commodities from all major sectors, particularly those showing investment traders holding large net-long futures position, came under heavy pressure from what looked to be investor long-liquidation selling.

Why? While many of the investors may not be in the banking industry in question, the idea of forced selling of physical commodity ownership would be enough to skew the perceived supply-and-demand situation. Therefore, investors from other areas would look at reducing their exposure to out-of-balance, fundamentally, markets. Crude oil's Friday move certainly looks to be the poster-child of such a situation, falling to a loss of almost $2.00 after trading higher earlier in the day. Ag commodities aren't immune to the ripples either, with investment traders holding a large net-long position as of the most recent CFTC Commitments of Traders report. On the other hand, corn and wheat saw light support as investment traders covered a portion of their net-short futures position.

As with threats of a rate hike, tighter restrictions are nothing new to the banking community. For years, banks have been slowly winding their way out of the physical commodity sector, expecting tighter trade restrictions. The article states the Fed would impose an "unusually steep" 1,250% capital charge on banks to push them out of remaining physical commodity businesses. Wall Street Journal's article also points out that public will be given a 90-day comment period, with the deadline Dec. 22, and the rule taking effect after that. Interestingly enough, that is one week after the FOMC (Federal Open Market Committee) December meeting where an interest rate increase is expected.

To track my thoughts on the markets throughout the day, follow me on Twitter:www.twitter.com\Darin Newsom

-- DTN Senior Analyst Darin Newsom

(CZ/SK)

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