The HRC price rally continues unimpeded, as spot indexes are nearing $700/st and mills are hoping to increase prices further in the weeks ahead. Due to limited spot availability and extended lead times, additional price increases will likely be pushed without a formal announcement. Right now, there is no spot price because there are no spot tons available for the rest of this year and January order books are closed as mills wait to finalize contract negotiations. This rally has allowed mills to reduce discounts and maintain a similar proportion of their order book for contract tons compared to last year. This week, we will discuss how historically relevant downside risks relate to the current market dynamics and how the next few months could play out.

In a normal steel price cycle, a run-up in price usually coincides with downside risks increasing in magnitude and importance. For example, basic economics tells us that demand should decline as buyers are forced to pay higher prices for a good. However, this assumes that buyer’s budget is relatively constant, which is not the case in the current environment. Consumers across the country have reduced their spending on services such as dining, travel, concerts, gym memberships etc. This gives consumers more discretionary income to allocate to goods, which have become much more desirable during the coronavirus pandemic. The below chart shows seasonally adjusted annual rate (in percentage terms) of consumer spending on both goods (blue) and services (white).

Demand for goods held up much better than that of services during the spring and summer, and over the past quarter, has accelerated among changing consumer preferences. So instead of seeing an exhausted steel buying community after a significant price rally, we are witnessing a second wind from buyers as the economy recovers and demand for steel accelerates.

As in other commodity markets, higher prices usually spur increases in supply as producers try to sell larger quantities at elevated prices. This prevents prices from rising to levels that are unsustainable. However, domestic steel producers have maintained reduced production levels for several months, driven by both maintenance outages during the fall and extended furnace idling, which the market did not expect. Similarly, as the domestic price rallies, differentials with global prices grow, increasing the likelihood for imports to alleviate the supply shortage. However, quarterly and annual quotas and the lengthy lead-time for bringing in foreign material will prevent a surge of imports for the remainder of this year. Therefore, we see no fix in the short term the structural steel shortage in the domestic market. Moreover, we might not have seen the worst of this short squeeze yet. The longer these dynamics last, the worse the shortage gets because inventory levels decline across the supply chain. The spot market has dried up, and now the limited spot transactions can significantly influence market indexes, and thus drive this market significantly higher into next year.