Markets have ignored the impact of drought on inflation, bond yields and equities
Key agricultural commodity prices could cause an unexpected spike in US, European and Asian producer and consumer inflation. The key question is to what extent?
If indeed there are signs of unexpected acceleration in price rises, US, European and Asian bond yields could rise in tandem with a decline in bond prices. The market fear would be that central banks may decide to slam on the brakes, causing a sharper than expected rise in short-term interest rates. But regardless what central banks do, market forces could cause a jump in bond yields and hence, short, medium and long-term rates.
So far, markets haven’t factored in this potential “black swan” and expect at worst only a slight rise in US Federal Reserve rates, followed possibly by the Bank of England. The European Central Bank has been relaxed about inflation.
Other than the Facebook plunge, US, European and Asian equities have hardly moved.
Gold prices, which historically have tended to rise on expectations of higher inflation, have done the opposite.
From the peak of $1,365 an ounce in April this year, gold has slid by 10.7 per cent to $1,218 an ounce– around the lowest levels of its one-year trading range.
Despite the majority of economists and market strategists’ sanguine views of inflation, agricultural and energy markets are telling a different story.
High temperatures and severe drought in Europe, US and parts of Asia have caused farmers to fret about their crops.
There was some relief with some rain in northern Europe. But weather forecasters are saying that severe storms could damage crops further and that hot weather will soon return. Climate change is being blamed.
In the past six months to a year, wheat prices have jumped by 16 per cent and rough rice by 14 per cent on US commodity exchanges. Although there were recent dips, helped by the Trump Administration’s US$12 billion farmer relief programme, soybeans, corn, cattle, hog and sugar prices are well up from the low levels of last year. Cotton has risen by 31 per cent.
Natural gas and oil, commodities indirectly affected by the heat, are also affected, as businesses and homeowners have boosted their air conditioning. In the past year, Brent crude oil has soared by 63.5 per cent and natural gas prices by 10.8 per cent.
“Unfavourable weather for 2018/19 crops in several key growing regions is expected to cause world total wheat and coarse grains production to fall by 2 per cent year on year to a three-year low of 2,059 tonnes,” said a July report released by the International Grains Council.
“A particularly steep decline is anticipated for the wheat crop, but also with reductions for barley, oats and rye. A projected increase for maize largely hinges on a recovery in output in South America, where planting for the 2018 to 2019 crop is still some months away. The declines are happening in the face of a fresh high of 2,128 tonnes in grains consumption,” the report added.
Global stocks have been depleted for the second year running. Fortunately for Asian rice consumers, “global rice trade in 2018 is forecast to expand marginally as weaker demand from sub-Saharan Africa and China, contrasts with bigger dispatches to South-east Asia”.
While rice output in China could decline in the 2018/19 crop, gains in India and other producers should underpin a record world outturn, the Grains Council predicted.
The main question is to what extent agricultural and energy prices will boost global inflation.
Continued easy money and minimal central bank rate rises continue while unemployment has fallen and labour conditions have tightened in the US, Germany and UK.
As a result, overall inflation has already risen sharply in the US, Japan Europe and Asia in the past three years.
In the US, it is 2.9 per cent, from zero at its low; Germany, 2.1 per cent, from negative; the UK, 2.4 per cent from 0.5 per cent; France, 2 per cent from zero; Japan, 0.7 per cent from negative.
Inflation in China and India are well up. Singapore’s erstwhile negative inflation numbers have also transposed into a marginally positive inflation of 0.6 per cent.
Of course, these global consumer price rises cannot be regarded as excessive.
The history of inflation, however, shows what the late economist Friedrich von Hayek described as “catching the tiger by its tail”. In other words, once the inflation beast begins to rouse, it is difficult to control.
As prices rise, businesses and consumers begin to anticipate further increases, leading to further purchases and price increases. It is also easier for unscrupulous business people to profiteer.
© copyright Neil Behrmann
This article was first published in The Business Times, Singapore on July 31.
Neil Behrmann is London correspondent of The Business Times. Jack of Diamonds his thriller on global diamond mining and smuggling, has recently been published. It is the sequel to the thriller, Trader Jack, The Story of Jack Miner.
See reviews of both books on: https://www.amazon.co.uk/Neil-Behrmann/e/B005HA9E3M