Spot activity in the domestic steel market remained muted over the last week as most buyers continue to place tons through their discounted index contracts. Mills remain firm in holding spot offers above the expected transaction prices, but at slightly lower prices than in previous weeks. The HRC futures curve remains in backwardation for February through April, signaling that lower spot prices are expected over the next few months. Additionally, the curve shifted into contango (front month expirations at lower prices than back months) starting in April, which tends to occur as the market is weakening. The busheling scrap curve expects March scrap to move about $10 lower, which would squeeze mill profitability as HRC prices are expected to fall more. These ferrous future curves display market expectations, but historically have been poor predictors of actual prices in the future.

The negative outlook in the market is apparent, and there are several factors that may be driving it. First, the expectation is for slightly higher imports (below) in January compared to previous months as quotas reset and delayed material enters in the New Year. While the level of imports remains historically low, this increase reflects fewer tons placed domestically. Next, we continue to see lingering effects from the coronavirus outbreak in commodity and financial markets. The US Dollar continues to strengthen, as the domestic market remains a safe haven, which puts pressure on global commodity prices. Finally, and most importantly, there was not enough demand in the domestic ferrous market at higher prices to sustain the price rally that started in October. Distributors restocked late last year at significantly lower prices, but as inventory levels shrink, we are not seeing significant restocking at the current spot prices. This leads to two important questions for everyone in the market: What is the demand outlook and what price level will spur this demand?

Last week, several relevant demand indicators (detailed below) were released, and the contents of the ISM Manufacturing PMI report is best to help decipher current manufacturing demand and form future expectations. The below chart shows the Platts Midwest HRC Index and compares it to the headline ISM Manufacturing PMI reading.

The manufacturing PMI bounced back above 50 into expansionary territory in January after declining throughout 2019. This index is one of the best gauges of manufacturing demand, and it tends to closely track the spot HRC price. The move up in January follows the rally in HRC prices seen at the end of last year, and reflects the view that the demand outlook is strengthening compared to the end of 2019. This leads us to believe that while the current spot HRC price may be too high, the actual price that will incentivize buyers is much higher than where it bottomed in October of last year. The futures curve shows expectations of prices bottoming near $550, which provides a great risk/reward for buyers to lock in prices for the year. Moreover, should demand surprise to the upside, spot prices may bottom at a much higher price, and those who waited for lower prices would have missed this opportunity.