Signs a global recession could be on the cards
The US economy seems almost certain to fall into recession this year, despite falling commodity prices dragging global inflation lower.
A recession in the United States looks a near certainty during 2023.
The US Federal Reserve has increased interest rates again, emphasising what it calls “ongoing high inflation”. It is largely ignoring the indicators pointing to slower economic growth, which many good economists fear is a precursor to a recession.
One issue the Fed and many others are overlooking when it comes to assessments of the global economy and overarching inflation pressures is commodity prices.
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The measure of commodity prices is one of the best real-time indicators of global economic conditions, including for inflation.
The Commodities Research Bureau (CRB) produces an index of commodity prices, which incorporates the price of items as diverse as oil, natural gas, gold, timber, iron ore, copper, wheat, soybeans, rubber, orange juice and many others.
It is a great measure of economic conditions because the price of these items is determined by the interplay of global demand and global supply, and it provides a leading indicator of broad inflation momentum when prices swing higher or lower.
The CRB index of commodity prices has a strong track record in the early detection of turning points in economic growth and, importantly, inflation momentum, and it has the advantage of being updated in real time.
COVID causes commodity crush
In April 2020, with the COVID pandemic spreading around the world, billions of people locked down and global trade dislocated, the CRB index slumped to its lowest level in 20 years.
As we now know, the global economy went into a deep recession and inflation fell sharply. In some countries there was outright deflation – a period of general price falls as the free-fall in commodity prices impacted business costs.
From that low point in April 2020, and over the next 18 months or so, the world learnt to live with COVID, the lockdown measures eased, vaccinations were developed and administered and the effects of lower production were felt. The CRB index started to increase - and sharply.
This was a critical issue in the unleashing of inflation pressures that came to dog the global economy from the middle of 2021, and is still being seen today.
Indeed, from April 2020 to June 2022, the CRB index rose a massive 165 per cent, a move which saw the cost of doing business increase - be it in transport, construction, food growing and production or manufacturing. Firms simply passed on these higher costs to consumers, which underpinned the inflation upswing.
Fast forward to today and recent trends in commodity prices: from the peak in June 2022, the CRB index has fallen by 20 per cent. Commodity prices in aggregate are in fact lower now than in 2005-2006 and 2011-2014.
There is no coincidence that this recent trend has triggered a clear turning point lower in inflation around the world. Inflation is falling.
As the lower prices of commodities feed into transport logistics, manufacturing costs, the price of food, construction materials and all manner of areas of the economy, inflation will continue to fall.
From a consumer perspective, note the effect of the 50 per cent fall in global oil prices. Petrol prices are down from around $2.25 a litre to around $1.75. This will trim inflation in a direct way. Lower oil prices also ease pressure on trucking costs and airfares, which again will feed into lower inflation.
These trends are evident for astute investors, with money markets pricing in interest rate cuts over the next six-12 months. No more interest rate hikes.
If global commodity prices remain weak, the fall in inflation through the remainder of 2023 and into 2024 will be material. Indeed, it remains likely that inflation will return to the RBA target range of 2-3 per cent in the next year or so, a point which means not only no more interest rate hikes from the RBA but opens the door for possible rate cuts - even with the US hiking its interest rates.
That is what the money markets are now pricing in.
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