Inflations & Correlations
Macroeconomic influences continue to dominate market headlines. This report analyzes common assumptions and correlations between commodity markets, food, and monetary policy.
News and opinions this week have been fairly consistent about the impact on agriculture of the banking failures. To sum up:
It is by and large a U.S. and an EU phenomenon.
Less developed economies will feel the pinch of tightening credit, as well as farmers in these countries.
Agriculture in countries with more stable banking systems will be less impacted, however, borrowing costs are still higher than anyone can remember.
Less consistent are the correlations being made that drive inflation. Much confusion and uncertainty stems from food systems being governed by domestic policies, industry consolidation, weather and supply chain vulnerabilities.
Consider these numerical discrepancies in inflation rates:
Food price inflation continues in Canada, according to the latest data released this week by Statistics Canada. February was the seventh consecutive month of double-digit food price inflation… and in the meantime, the Consumer Price Index (CPI) cooled to 5.2% year over year.
The media referenced the usual explanations for high food prices in Canada, namely the war in Ukraine, high input costs, supply chain disruptions, and extreme weather. As was reviewed in this recent issue of Prairie Routes Research, grocery retail margins might also play a role, but it’s impossible to know without any data or reporting from behind the shelves.
What we do know is February’s annualized food price inflation in the U.S. was 9.6%, compared to 10.6% in Canada. According to the U.S. Bureau of Labor Statistics, food inflation cooled for the 6th straight month in February. North of the border, Stats Can reported February 2023 as the 10th consecutive month of double-digit food price inflation.
While there are many commonalities between food distribution and retail pricing in Canada and the U.S., clearly there are some discrepancies that have led the former food economy to cool off slower than the latter.
Canadian vs. U.S. Food Systems
To start to understand the divergence in food price trends between the 2 neighboring economies currently, consider:
Population density. Food costs have always been severe in Canada’s remote communities. And there is an overall lack of competition in retail markets for food, i.e. if Canadian grocers don’t want to lower their prices, most likely they won’t.
Consumer demand trends in the U.S. are understood and commercial supply responses are well underway, as outlined in detail here, by Food Business Journal. There is enough purchasing depth by U.S. food consumers for diverse, smaller and mid-sized businesses to get off the ground.
Regional initiatives that favor locally-produced food and ingredients are popping up in jurisdictions across the U.S. like New York and Wyoming. There are a few groups in Canada working on similar ideas, but the spreads in ingredient prices between commodity imports and local production are still, in general, prohibitively wide.
What’s NOT Driving Food Price Inflation
Last year, the war in Ukraine fueled commodity market rallies around the world, in the interrelated markets for fertilizers, energies, and grains. All have since sharply corrected lower.
There is a lag in the responses of correlated markets due to substitution and hedging effects, yes, but the argument that input costs today are driving food inflation no longer adds up.
Here’s how some markets pull in the same direction:
Globally, fertilizer prices are driven by energy markets because liquid natural gas (LNG) is the #1 ingredient in products like urea and UAN.
Regionally, fertilizer prices are also driven by corn and canola acres in North America because those crops are the biggest nitrogen users.
Corn and canola prices are driven as much by energy markets as by food and feed demand, because of biofuel mandates in North America.
Grain and beef prices are correlated because the price of corn is a major variable in feedlot margins.
Corn leads all other grain commodities, via the math of substitution economics, and because it is the biggest crop.
All of these markets have traded lower for months now, and therefore, cannot be a current cause of food price inflation.
The Missing Links
It will come as no surprise to readers of this research series that the missing link between raw agricultural commodities and food prices is a lack of domestic processing capacity. In some cases, for example Canadian organic wheat flour, the raw grain is sometimes even imported. Compared to locally-produced organic wheat, domestic flour mills can find cheaper and more consistent origination overseas.
Breaking it down further, with the exception of supply managed goods and meats, Canada imports nearly all of its food in one form or another. From fresh produce to organic grains to CPG packaged goods, Canada is typically not the manufacturer of the foods on its grocery store shelves. That makes it tough to substantiate a link between input and retail prices.
Wholesale and retail food industries, as well as grain and beef, are globally-controlled by corporate giants in opaque supply chains operating as oligopolies. It is not possible to see inside the supply chain pricing and therefore impossible to substantiate correlations.
As the saying goes, ‘you can’t manage what you don’t measure.’ Taking a hard, honest look at the true economic drivers of food price inflation - to better manage and predict it in the future - is a necessary next step to achieve domestic food security.