Friday, 10 March 2017

What will Rate Increases Mean for Commodity Prices?

For a one percentage point increase in interest rates the high end of past research suggests a fall in agricultural commodity prices of five or six percent (Frankel), with other results (including mine) suggesting smaller impacts. My recent research with Amatov suggests that interest rate sensitivity is still in this range even during the period of the Fed's historically unprecedented interventions, with our estimate for this period still being below Frankel's. Thus, the increase in interest rates anticipated by the start of next summer's harvest should be expected to cause at most a two or three percent decline in agricultural commodity prices. That means roughly a dime or so per bushel for corn and wheat and maybe a quarter per bushel for soybeans.
However, given that the relationship between interest rates and commodity prices is well known, the futures markets for agricultural commodities likely have already partially priced in those impacts. I would not expect the inevitable increase in interest rates to be positive for commodity prices, but the magnitude of the negative impact should be relatively small and fairly evenly spread across the major row crops.
The effects generally manifest themselves slowly, with full adjustment to a new equilibrium level after interest rate moves taking about a year. Further, there is some evidence of overshooting when prices adjust, meaning that prices might drop sharply in the first few months and then recover some of those losses over the next year as everyone adjusts to the new level of interest rates. Therefore, if you see a big move in commodity futures prices after the Fed's first announcement of a rise in their interest rates, do not panic; things should settle down.

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