The Fed says wild swings in commodities markets are ramping up the risk of ‘contagion’ that could hit global banks hard

The wild volatility in commodities prices is raising the risk of contagion that would hit global financial institutions hard, the Federal Reserve has warned, as it rang the alarm bell over worsening trading conditions in major markets.

Commodities such as oil, metals, and wheat have been on a rollercoaster in 2022, while stocks and bonds have fallen dramatically, as investors digested rising interest rates, Russia’s invasion of Ukraine, and red-hot inflation.

Fed Vice Chair Lael Brainard warned the Russia-Ukraine war is a particular risk for financial institutions trading in commodities, speaking in a statement accompanying the Fed’s latest financial stability report on Monday.

“Russia’s unprovoked war in Ukraine has sparked large price movements and margin calls in commodities markets, and highlighted a potential channel through which large financial institutions could be exposed to contagion,” she said.

Contagion is where losses in one market cause institutions such as banks to pull back from other markets, driving widespread losses in a snowball effect.

The Fed pointed to the surge in the price of nickel in March, which left a Chinese tycoon facing huge losses and caused the London Metal Exchange to suspend trading. JPMorgan and other major institutions were heavily caught up in the chaotic episode.

It said clearing houses, key middlemen institutions in financial trading, have sharply increased so-called margin calls in key markets such as oil futures, adding to the pressure on major buyers and sellers. A margin call is a demand to cough up more cash to cover potential losses.

The central bank also said liquidity conditions have worsened notably elsewhere, meaning traders of key global assets are finding it harder to buy and sell without moving the market.

“While the recent deterioration in liquidity has not been as extreme as in some past episodes, the risk of a sudden significant deterioration appears higher than normal,” the Fed report said.

“Liquidity has been somewhat strained at times in oil futures markets, while markets for some other affected commodities have been subject to notable dysfunction.”