US Perspectives: Don't See Dark Clouds in Falling Commodity Prices

Though markets dropped as commodities swooned, the recent plunge in commodity prices portends better news on the inflation front, says Morningstar's Bob Johnson.

Robert Johnson, CFA 17.05.2011
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The week before last week saw a sell-off in commodities that took some of the sting out of last week's announcement of April's inflation data. Last week, agricultural commodities took another downward move as government crop reports indicated increased production of key crops including corn and wheat.


One might hope that falling commodity prices, one of the real thorns in the side of the economic recovery, might be viewed positively by Wall Street. Instead, stock markets sold off last week and bond yields declined as investors feared that falling commodity prices were indicative of a weaker economy. However, I believe accelerating employment growth and slowing inflation (due at least partially to increasing supply of key commodities) seem to be more indicative of improving economic growth in the quarters ahead, not a decline.


The End of QE2 Could Bring Down Both Commodities and Stock Markets

I also suspect that both stock market assets and commodities that seemed to benefit so much from QE2 (quantitative easing part II, the Fed's bond repurchase program meant to reduce long-term interest rates resulting in higher asset prices and a falling dollar) are beginning to anticipate the end of the program in June. Perversely, long-term rates have been falling for some time even as QE2 comes to an end. A fear that the economy might slow as the program comes to an end (and no new program is proposed) is the primary reason for the rate decline, in my opinion. I continue to believe fears of a declining economy are misplaced as consumers continue to spend, at least according to the weekly shopping center data, and that's with gasoline prices just beginning to edge downward.


Mixed Economic Data, Again

Last week's economic data contained no big surprises. The trade deficit was slightly higher than expected due to higher oil prices. Meanwhile, consumer prices and producer prices for April were elevated but in line with expectations; both were below recent recovery highs.


The recent plunge in commodity prices portends even better news on the inflation front in the months ahead. Initial jobless claims fell back some, offsetting some but certainly not all of the recent runup. Retail sales came in a little lighter than I had anticipated, and gasoline price increases accounted for a good part of the improvement. Based on same store sales data, I suspect these below-par results may be revised upward next month. Inventories also remained under control, as the key ratio comparing total inventories to sales set another record low this month. Inventory levels remain surprisingly low for this stage of the recovery, hardly an indicator that the economy is about to fall back into the abyss.


Inflation May Be Peaking

The consumer price index, after consistently accelerating monthly increases, finally backed down in April. After increasing 0.5% in each of the last two months, the index backed off to 0.4% last month. That reading was before energy prices began to back off earlier this month. The majority of categories showed a smaller increase than in the prior months, including food, energy, and transportation services. The one nasty surprise in the data was that both new and especially used car prices accelerated dramatically due to a combination of supply shortage of used cars (very few cars were produced in late 2008 and 2009) and tightening supplies of new cars related to the potential shortages of Japanese cars because of earthquake-related supply chain issues. Used car prices were up 1.2% in April and the Manheim Index of Used Cars set a new record. Even new cars managed a 0.7% increase. That's monthly, not annualized data.


Is April the Start of a Decline in Inflation?

Increases in CPI

Monthly % Change















Source: Bureau of Labor Statistics


On a year-over-year basis, which takes out some of the monthly volatility, the consumer price index showed a 3.2% increase. Before all is said and done, I suspect this index will be up 3.5%-4.0% on a year-over-year basis within the next month or two, just short of the 4%-5% that has triggered past recessions.


Agricultural Products May Help the Inflation Indexes to Back Down

Prices for various cereal grains have been on the decline for the past month. Our agricultural equipment analyst, Adam Fleck, believes that other crop prices might be due for some moderation in the year ahead, too:


USDA's initial outlook for the 2011-12 planting year is good for consumers, bad for producers. Last week, the U.S. Department of Agriculture released its initial global outlook for crop production and prices during the 2011-12 planting and harvesting season. Earlier this year, we theorized that increased planting, less-severe worldwide weather patterns, and slower growth in U.S. corn-based ethanol production would lead to rebounding crop surpluses and headwinds to prices of corn, wheat, and soybeans. Although only an early read into the situation, the USDA's take on next year's production seems to bear out our thinking. The group sees mid-single-digit production growth in corn and wheat globally, driven largely by rebounding Russian wheat and U.S. corn harvests. With more moderate demand growth in line with historical averages, the USDA expects these crops to stem the worldwide shortages seen in 2010-11. For soybeans, increased demand is expected to outstrip flat production levels, but the organization still sees this crop in surplus as well. In all, the USDA expects higher average pricing for the upcoming harvest season but sees growth at a slower rate for both corn and soybeans; only wheat's price is expected to grow at a faster clip.


Gasoline Prices Are Due to Fall

As oil has fallen from $115 to under $100 a barrel, gasoline prices have yet to fall as much. I suspect gasoline prices could fall $0.25 or more in the weeks ahead. Various refinery issues as well as the potential flooding of some refineries in the Mississippi River Delta have kept lower oil prices from immediately translating into lower prices at the pump.


Retail Sales Grow 0.5% in April, Previous Months Revised Up, Another Revision in the Cards

The government's estimates of retail sales for April fell short of expectations for growth of 0.8% as the first official estimate of retail sales came in at 0.5%. Based on past upward revisions, I think the consensus estimate may prove closer to the mark than this month's initial government report. Last month's official retail sales figure was revised up, to 0.9% from 0.4%. That was just off by 125%!


Since that March figure was included in the first quarter's GDP forecast, my guess is that 1.8% real GDP growth estimate is likely to be boosted by at least a tenth or two. Based on the fact that most of the past retail sales reports have had to be revised upward and the fact that the International Council of Shopping Centers reported very strong reports for April, I strongly suspect this month's official number will also be subject to upward revision.


Consumers Spend More Time (and Money) at Home in April

The April report, if it stands up to revisions, was characterized by consumers staying at home. Restaurant sales were down 0.1% this month, and grocery store sales were up a stunning 1.5% as it would appear that consumers chose to eat at home instead of going out this month. Nonstore retailers--mainly online retailers--saw sales increase by a full percentage point. Gasoline station sales increased 2.7%, but according to the consumer price index, gasoline prices jumped a higher 3.3%, indicating that the number of gallons of gasoline purchased went down in April. Higher gasoline prices are beginning to change behavior.


Trade Deficit Shows Modest Increase Due to Oil Imports and Oil Prices

While the trade balance increased to $48.2 billion for March compared with $45.5 in February and close to a recovery high, there was some good news lurking below the headlines. A combination of temporarily higher quantities of oil and sharply higher prices pushed oil imports up by about $6 billion. Looking at the data excluding petroleum products (both exports and imports--yes, we actually export some oil products), the deficit has improved in recent months.


Excluding Oil, the U.S. Trade Deficit Continues to Shrink


Trade Balance Total

Trade Balance Ex-Oil



















Source: Census Bureau


Given that prices have fallen recently and that U.S. drivers have begun to cut back on driving, I suspect that oil may not be as big a drag in the months ahead. The (excluding oil) data above seem to indicate that a weaker dollar is beginning to have positive effects on our trade deficit. Capital goods and agricultural goods seem to be leading the way, especially in Asia and with our North American trading partners. The deficit (excluding oil) is now at a relatively modest 1.3% of U.S. GDP. Now if only the U.S. could begin to work that oil deficit down a little faster.


Housing News and Manufacturing Data on the Docket

This week brings the industrial production report for April, and I believe the consensus forecast of 0.4% growth for April will be in the ballpark or perhaps just a bit low. This still represents some slippage from the 0.8% recorded in March. The results for utilities tended to inflate the March statistic. On the other hand, the April PMI barely budged compared to March, so the non-utility-related slippage should be minimal. The only large wildcard is auto production. While the recent employment report indicated that things were going well through April 16, some of the U.S. plants of Japanese auto manufacturers began to feel the effects of parts shortages from Japan. There may even have been a few layoffs related to these shortages in the back half of the month. So if anything odd shows up in this week's headlines, auto production would be the first place I'd check.


Not Looking for Much Change in Regional PMI Data

Looking ahead to May's data, two regional purchasing managers' reports are due this week: the Philly Fed and the Empire State. The consensus forecast is for both of these reports to be relatively flat with the prior month with readings of around 20 (zero represents no growth, positive numbers represent growth). Lately these reports have been quite volatile and often contradict each other, so I wouldn't read much into them unless the moves in both indexes were large and in the same direction.


Housing Starts: Very Modest Improvement Forecast

Housing starts surprised on the upside in March as weather improved sharply from February to 549,000 units. I really wouldn't expect a lot of improvement in April, based on a modest decline in rail shipments of construction-related materials last month. I am not so sure the weather improved quite as much as it did in March either. I continue to believe dramatically improved housing starts remain a 2012 event. (Starts bottomed at around 500,000 units and peaked at over 2 million units during the housing boom of the 2000s.)


Existing Home Sales Due for a Lift

Given a 5.1% increase in pending home sales for March, I suspect that existing home sales will do better than the 2% consensus increase. I believe that sales of 5.3 million (seasonally adjusted annual rate in units), an increase of 4%, is a real possibility. Improved employment data of late also bolster my confidence that April's existing home sales data should look better than March's. A recent National Association of Realtor's report pegged full-year existing home sales at 5.1 million units, a 7%-10% increase from 2010 levels, a period that included special housing tax credits.


This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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