Real commodity prices and the U.S. rate cycle

February 10, 2010

— John Kemp is a Reuters columnist. The views expressed are his own. —

Commodity prices exhibit a strong cyclical component — though it can be masked when producers are carrying a lot of excess capacity.

The attached chart shows the real price of various commodity baskets (Jan 1980=100) overlaid by U.S. interest rates (discount rate, later funds target), and the business cycle (NBER Business Cycle Dating Committee).

Prices began rising well ahead of interest rates after three of the last four recessions. Commodity markets anticipated future increases in demand even as policymakers prefered to hold back while recovery became more firmly established.

The current price rebound is unusual only for its strength.

Part of the explanation is the increasing weight of China and other emerging markets in global commodity consumption. As a result, the U.S. business and rate cycles and those of the other advanced economies now affect less than half the consumption of many commodities worldwide.

Prices are geared to the global cycle, which is not captured by measures of industrial output and capacity in the United States and the rest of the OECD.

The other factor is the increasingly forward-looking nature of commodity markets as investor participation increases and liquidity moves further along the forward curve. Futures markets increasingly look through nearby weakness to focus on a cyclical recovery and the re-emergence of capacity constraints

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