Last week was relatively quiet with continued steady interest in quoting and purchase orders from FGM customers.  Regarding flat rolled price direction, there remains more questions than answers and we remain cautious and risk-averse.

China’s return from the Chinese New Year holiday failed to produce any follow through in iron ore, which was down heavily on the week.  Nevertheless, at $85/t, iron ore remains at very strong levels.  Scrap prices followed iron ore lower.  Trade talks between the U.S. and China continue without any concrete results.  However, the Chinese yuan has appreciated in recent weeks perhaps indicating China’s expectation of a resolution or at the very least a delay to the March 1 deadline for another tariff increase.

China has proactively fought the trade war induced drag on their economy on a number of fronts.  Last week, January new yuan loans and aggregate financing data exceeded expectations as the P.B.O.C. continues to provide ample liquidity to the Chinese economy. Both charts compare monthly data on a YoY basis.  2019 data is in red.

The P.B.O.C. continued to increase assets on its balance sheet through December.

However, fixed asset investment grew at its slowest YoY rate for the month of December back to at least 1998 (when records started) and remains subdued below 6%.

China’s December auto sales fell to the lowest level in years (green).

Chinese finished steel inventory levels (red) exceeded those seen this week in 2015, 2016 and 2018.  2019 HRC inventory is in line with this same week in 2018, while rebar inventory still trails the level it was at this week in 2018.

Taken together, these charts show liquidity and dovish monetary policy has been administered to stimulate the Chinese economy.  However, fixed asset investment and auto sales fail to see a material pick up.  This begs the question of whether the recent rally in iron ore, rebar and HRC futures is forecasting an economic rebound in these steel intensive industries or if it is simply a speculative rally fueled by increased liquidity and momentum.

U.S. import licenses continue to point to subdued import levels and pricing differentials inclusive of the tariffs look prohibitive creating a tighter supply situation in Q2 and Q3.

Last week’s report presented these two questions:

• Is there too much steel in the U.S.?
• Will the steel tariffs be reversed?

Last week’ report showed:

• Net flat rolled imports increased in the first eleven months of 2018 vs. the same period in 2017 despite the tariffs
• Domestic crude steel production increased significantly in 2018
• Domestic capacity has increased
• Steel mills are showing a material increase in inventory on their balance sheets.

The MSCI reports January service center shipments and inventory this week.  Typically, months-on-hand falls sharply in January due to rebounding shipments.  One caveat is the last two days of January were hit with the polar vortex, which may have slowed shipments.  Inventory changes in January are less black and white than shipments.  Service centers struggled through the second half of 2018 taking in higher priced steel in a rapidly falling price environment.  Most continued to be in a destocking mood in January with some in jeopardy of breaching covenants with their financiers.  Service center destocking increased the pressure on domestic mills order books, which might be on the rebound in February as service centers look to max out volume on index-based deals, especially those deals discounted to the index.  Keep an eye on lead times to see how much of an effect this has in this new environment of increased capacity.  Recent economic data indicates steel demand has been slowing.  In addition, steel buyers have been very price sensitive.

At current tariff inclusive levels, import differentials are unattractive, which historically results in strong domestic price gains to come.  However, has the increased domestic production capacity and inventory levels seen at the mill and distributor level mitigated some of this effect?  How much has this additional capacity changed this calculus?

Also, the uncertainty regarding the Bicameral Congressional Trade Authority Act of 2019 (there were no developments regarding the legislation last week) could be a drag on purchase orders for if it is passed and tariffs on Canada, Mexico and the E.U. are reversed, a sharp price correction is certain.  This uncertainty is likely to leave the industry in a more risk-averse mode.

Pay close attention to Chinese finished steel and iron ore prices.  If they reverse course, the import window will open back up sending domestic flat rolled prices lower.

The following issues provide the foundation of our view:

• Declining rates of growth in manufacturing and tariff induced demand destruction
• Increased/increasing domestic steel production capacity
• Weakening global economics
• Crude oil price falling sharply
• Higher interest rates
• Strengthening U.S. dollar
• S. residential construction industry slowing
• Slowing auto sales
• Falling global flat rolled prices
• Tariff resolution potential