Is The Worst Of Food Inflation Over?

AT-A-GLANCE

• Declines in crop prices could help ease food inflation
• Wheat and corn prices have retreated, soybeans are off their peaks yet have rebounded a little
• Inflation remains elevated despite easing to 8.5% in July from 9.1% in June
• Chinese demand for commodities could impact pace of food inflation 

The futures price of Chicago corn is near a six-month low, wheat has retreated nearly 40% from its peak after Russia began its invasion of Ukraine in February, while soybeans are off their peaks yet have made small gains recently (Figure 1). Could the downtrend for the three crops used as both livestock feed and in foods such as bread and spaghetti be a precursor for the path of food inflation? 

Prices for a range of other food-related commodities have also been retreating from recent highs. Palm oil, widely used in cooking is down 36% from its April high as of this writing, while canola, used to produce cooking oil, is down 31% from its May peak. Cheese prices are down about 15% from their mid-May high, while prices for breakfast cereal oats are down 43% from their mid-April high.

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While these are indications that food inflation could possibly ease in coming months, their decline to pre-pandemic levels could be protracted as evidenced by still high prices for some other food-related products. Milk, for instance, while down marginally from its peak in May is still 41% higher from a year ago. Rice, a staple in Asia and consumed across the globe in various forms, is up 26% from a year ago, and breakfast beverage orange juice is up 34% from this time last year.

Adding to the expectations for food inflation to simmer down in the coming months is the decline in the prices for crude oil, another critical cost component in the production and distribution of food. Crude oil is well off its peak of nearly $120 a barrel when Europe partially banned Russian oil, falling below $90 briefly for the first time in six months in August.

A substantial amount of farming costs are attributable to fuels such as gasoline and diesel that drive equipment necessary for the tilling of fields to planting of crops and harvesting, and for trucks, trains and barges in transporting them to end users and ports for exports. National gasoline prices are off their peak, falling to just over $4 per gallon after topping $5 in July.

Fertilizer costs are another significant part of food production costs, along with seed and fuel (Figure 2). There are also other factors such as wages, packaging and transportation. Wages, for instance, have been rising steadily by 5% amid a tight labor market, which seems robust despite negative economic growth in the first two quarters of this year. Job openings are outpacing the available labor by about a two to one basis, while the unemployment rate at 3.5% is the lowest in about 50 years. 

Figure 1: Corn, Wheat and Soybean Futures are in Retreat

Inflation, and prices of food in particular, have become a primary concern from consumers, policy makers and the Federal Reserve (Fed). Inflation soared to 9.1% in June compared to a year ago – the highest in 40 years -- fueled by lingering disruptions to supply chains that first surfaced during the height of the pandemic, and a surge in consumer demand for manufactured goods during the time of social sequestration to contain the spread of Covid-19. There was some relief when the inflation rate fell to 8.5% in July largely due to a decline in the price of gasoline. On a month-on-month basis, inflation was unchanged in July after growing 1.3% in June and 1.0% in May (Figure 3). Food costs, however, continued to climb in July, rising 1.1% month on month. Stripping away the volatile food and energy costs, core inflation rose 0.3% in July, the smallest increase since March.

Figure 2: Cost Components of Corn Farming

Food’s place in overall inflation

To get an overall sense of inflation, let’s take a look at the components that go into the basket of goods and services that the Bureau of Labor Statistics uses to calculate changes in consumer prices. There are eight major groups, namely food and beverages, rent (including owners’ equivalent rent), transportation, medical care, education and communication (that includes college tuition, postage, computer software), apparel (including shoes and jewelry), transportation and other goods and services. Purchases of homes are considered an investment expenditure and are excluded, along with investments in stocks, bonds and business expenses.

Of these, rent has the highest impact, accounting for 32%, food 13.4%, gasoline 4.8%, new vehicles 4.02%, medical care 6.8%, transportation services 5.8% and electricity 2.5%. Of food, cereals and bakery products – made primarily from wheat products -- comprise 8% (Figure 3). 

Figure 3: The effects of inflation on food-related segments

Inflation, which had been averaging around 2% for much of the past two decades, began climbing from more than a year ago amid the pandemic, and what was initially expected to be transitory by Fed has now become persistent to the extent that the Fed has raised interest rates four times through July to rein in the surge in consumer prices. With the labor market remaining robust despite the rate hikes, the Fed is expected to raise rates by another 50 to 75 basis points during its September meeting, according to the federal funds futures market. There is another meeting of the Fed’s policy-making Federal Open Market Committee (FOMC) in November 2022. While the magnitude of any rate hike at that session would hinge on the pace of inflation between now and then, federal funds futures suggest a smaller hike in November than in September. The Fed has a delicate job at hand – beat back inflation by raising rates just enough without tipping the economy into a recession. 

Soaring wheat prices retreat

Adding to the other factors stoking food inflation is the rise in prices for a range of commodities tracked to Russia’s invasion of Ukraine. Chicago wheat prices were trading at around $8 per bushel at the start of February, and by early March prices had rallied to $12.52, an increase of 56% amid concerns of supply disruptions as Russia and Ukraine are the world’s top and number five wheat exporters. Wheat prices neared $13 by May before falling below $8 in August.

Wheat prices have tumbled in recent weeks due to the United Nations brokering a deal with Russia for the resumption of Ukrainian exports through the Black Sea. There are also expectations for U.S. wheat production to be higher than last year’s despite some impact from the drought in some regions. An estimated 230 million bushels of wheat is expected to be turned into flour in 2022. Since the difference between the peak and current price of wheat is around $5 per bushel, the cost differential in the amount of wheat used to produce flour will be around $1.15 billion.

A small portion of the wheat forecast to be produced in the U.S. in the 2022/23 marketing year beginning June 2022 will also be used to feed livestock – corn and soybeans are the primary feedstock. The U.S. Department of Agriculture (USDA) is expecting 2022/23 production at 1.78 billion bushels, of which about 80 million bushels will be used as feed.

Soybean and corn

Soybean prices have rebounded after falling to their lowest level in six months in July, but prices have been rallying back to their recent peaks above $17 per bushel. Corn prices have retreated 23% from a high of $8.16 to just over $6, close to its lowest level in six months (Figure 3). The harvest of both crops will begin around September in the Midwest and the abnormally high heat during the summer could impact production and potentially lift prices.

Soybean prices rallied earlier in the year amid inclement growing weather in Brazil, the world’s largest grower of the oilseed, while corn prices were fueled by Russia’s invasion of Ukraine, the world’s fourth largest export of corn. Weather in July and August, when corn goes through pollination and soybeans set pods, respectively, will be crucial in determining final production for both crops.

About one-fifth of the 14.5 billion bushels of corn expected to be produced this year, or 5.35 billion bushels, will be turned into livestock feed. The decline of about $2 per bushel in the price of corn from its peak is equivalent to a difference of over $10 billion in feed costs. Similarly, about half of the soybeans to be produced this year, or 2.24 billion bushels will be crushed into feed for livestock. A $1 per bushel decline translates to a difference of well over $2 billion in feed costs.

Beef and pork prices

There has been no let-up in the rise of prices for pork. Retail prices stood at $4.91 per pound in June, according to the USDA, up from around $4.88 in April and May. But the recent drop in commodity prices might be impacting the prices wholesalers are paying farmers. In June, the price of pork from the farm to wholesalers stood at 68.30 cents a pound, down from 98.10 cents in February, possibly a reflection of the decline commodity prices (Figure 4).  

Figure 4: Shifts in Pork Prices as it Changes Hands

Data from U.S. Department of Agriculture

The wholesale to retail price has also softened marginally, from a high of 309.3 cents per pound in December 2021 to 285.9 cents in June. The retail value for beef seems to have peaked at 790.10 cents per pound in October 2021, having come down to 766.00 cents in June.

Live cattle futures fell more than 9% from their February high of 142.75 cents per pound but have since gained 7% from their May low to 138.92 cents, suggesting that beef prices could head higher if there is any severe damage to the corn and soybean crops during the summer. Lean hogs have rallied more than 70% from their low in December of 2021 (Figure 5).

Figure 5: Hog and Cattle Futures Prices Have Not Let Up

China’s Growth and Commodities Prices

The U.S. inflation rate could also be associated with something far beyond the country’s borders – Chinese demand for commodities. Demand from the world’s second largest economy for commodities such as soybean, corn, oil and copper, among others, have a direct correlation with prices due to the amount of these products that are purchased by China. For instance, China is expected to account for 59% of all soybeans imported throughout the world in 2021/22. Hence, Chinese demand is fundamental in determining prices for a range of commodities. But the Chinese economy is weakening, with its gross domestic product growing just 0.4% in the second quarter compared to 4.8% in the first quarter. Already there are signs of weakening demand.

USDA data shows that Chinese purchases of corn in the current 2021/22 marketing year (Sept/August) was running about seven million tonnes behind the previous year’s pace. For soybeans, the lag was about the same, with purchases trailing the year-ago pace by nearly seven million tonnes.

The troubled property sector has been a drag on the Chinese economy, along with lockdowns under the country’s zero-Covid policy, but exports from the world’s second largest economy surged in July, but expectations are that China will fall short of its growth target of 5.5% this year. If China’s growth slows as expected, there could be implications for prices of a range of commodities.

Bottom Line

Food inflation remains a major concern, but the recent decline in crop prices from their peaks might offer an indication that some of the contributing factors could be on the wane, although any inclement weather during the critical period heading into harvest could turn markets around. The drop in oil prices, another key component in food prices, might also point to a case of the worst being over, but wages have been growing at about 5% -- but still lagging inflation at 9.1% -- and could add to production costs, along with other related costs such as packaging and distribution.

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