Do higher commodity prices point to inflation?
David James |
29 April 2021
Commodity prices are returning to pre-covid levels, which may be a sign that the global money printing is starting to feed into inflation. Are higher interest rates coming?
One of the biggest movers is crude oil. Brent Crude has tripled from its low of about $US24 – treating the briefly negative price as the aberration it was – to be trading at $US65.90. This may be an initial sign of commodity price inflation, and the oil price has a multiplier effect through the economy.
Oil is not the only commodity showing strength. Iron ore spot prices have also tripled since the beginning of 2020 to be almost $US200 a tonne. Copper prices have more than doubled from less than $US2/lb to over $US4/lb.
Copper is seen as a leading indicator. The cliche is that the copper price ‘has a PhD in economics.’ Because of its importance as an input in manufacturing practices, “the price action is evidence of ongoing momentum in the post-COVID global economic recovery,” according to Stockhead.
Industrial production in China, which consumes around 55-60% of global copper supplies is tracking higher than pre-COVID levels, as is South Korea. Other major economic zones including Europe, the US, Japan and India have also recovered, while the widely-read monthly ISM manufacturing survey for the US economy just hit its highest level since 1983.
Little wonder that, in an environment of low interest rates, there is growing concern about inflation. A report from Bank of America has picked up key inflation commentaries from earnings calls, with raw materials, transportation, labor cited as sources of inflation and many plan to (or have already) raise prices to pass through higher costs.
“Cost pressures are certainly appearing in company earnings commentaries: while it is still early on in earnings season (less than 10% of S&P 500 companies have reported), Morgan Stanley notes that cost pressures have emerged as a prominent topic of discussion,” a Zero Hedge article notes. “This development is corroborated by a number of macro data points which suggest that a range of expenses are on the rise.
“Many companies will ultimately look to pass along price, but on a more near-term basis the strategist is watching how stocks trade as cost pressures impact results relative to expectations.”
With signs of inflation in America, how long before that starts to affect Australia? The high iron ore price will benefit Australia’s balance of payments and the high copper price is good for some miners. But with Australia’s soaring levels of household debt, higher interest rates would be extremely damaging to the economy.
The debt problem is global, not just Australia. It is only sustainable because of low interest rates. Global debts stand at $US284 trillion equivalent, representing 355% of world GDP. This probably underestimates financial sector debt and does not take into account derivatives.
According to Deutsche Bank, there is an increasing divergence between economic growth and debt defaults, however. Despite the economic devastation of the coronavirus, “defaults have peaked at a lower level than during the previous three big default cycles even as growth across many countries was at the lowest levels for several decades or centuries.”
“Because debt has become so large over this period, and of such extreme systemic importance, that when each cycle turns there is an ever larger policy move to ensure that many of the most heavily indebted entities don’t default and risk a severe contagion event for the global economy.”
That could all come to a shuddering halt if central banks start raising interest rates.