Rising commodity prices suggest more inflation is on the way

If you thought the price of food and rent had gone up, try taking a look at commodity prices.

Arabica coffee bean futures ended 2021 up over 75% and continue to climb. Cotton is at its highest level in about 10 years.

The problem with raw materials is that they go into just about everything we buy. And some of them also enter our minds.

Soybeans are up 13% year over year, according to Thomson Reuters. Aluminum increased by 54%. Anhydrous ammonia fertilizer is up more than 200% from the 2020 average. It largely boils down to what we’ve been buying for the past two years – a lot of random stuff.

“The pandemic has resulted in a substitution of goods for services,” said Craig Pirrong, professor of finance at the University of Houston.

Instead of going on vacation, people built a patio, got a puppy, food for the puppy, planters for all their new indoor plants. All of this requires raw materials, also called commodities. Producers weren’t ready because at the start of the pandemic, they cut back.

“So when we had this reduction in production capacity and all of a sudden we have this increased demand, you combine those two things and you get price increases,” Pirrong said. Commodity prices tend to rise move much faster than prices in the rest of the economy.

“Commodity prices will be a leading indicator of the rate of inflation in the United States,” said Jian Yang, professor of finance at the University of Colorado at Denver.

According to Yang, commodity prices mean there is more inflation to come in 2022, although not as wild as last year. Energy is one of the biggest drivers of all commodities. West Texas oil is up 61% year over year, Dutch natural gas is up 325%. And these numbers, more than any other, register with people.

“It’s almost shocking in fact that all of our measures of long-term inflation expectations are very strongly correlated with oil and gas prices,” said Matthew Luzzetti, chief US economist at Deutsche Bank.

Prices at the pump and the cost of heating our homes with gas have an impact on the evolution of inflation. And when people expect more inflation, more inflation can happen.

“And so I think it’s really important to think about how inflationary pressures can get,” Luzzeti said.

Commodity prices don’t just change what’s in our wallets, they change our minds.

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