Fed's weak-dollar policy helps buoy commodity price bubble

Nation's Restaurant News, May 19, 2008 by John T. Barrone

Rising global demand, China, poor global harvests, ethanol, biodiesel and overeager speculators all have played a significant role in the run-up of commodity prices. But it's been the Federal Reserve's easy-money policy that is the biggest culprit behind runaway food cost inflation.

Granted, a 3.25-percent, six-month drop in short-term interest rates will help lubricate the economy's financial gears. But with those lower rates has come an ever-weakening dollar that has fueled the commodity bubble more than any other factor. While there is no doubt that a huge influx of speculative money has helped inflate commodity prices, many hedge funds are actually speculating on the Fed's policy itself--by buying commodities as a hedge against inflation. As far as exports go, what foreign country wouldn't "buy American" given its 30-percent to 50-percent exchange rate discount on our goods and services?

The recent decline in commodities came after the Federal Reserve indicated that it would at least pause before further rate reductions. That caused the dollar to firm, speculators to at least partially exit commodities and commodity prices to fall. But an opportunity was missed. A stronger position by the Fed against future rate cuts could have been the first pinprick toward deflating a commodity price bubble that threatens to choke the restaurant industry and maybe even starve a few third world countries.

Beef--The supply situation is changing. Large placements of young cattle onto feedlots in late 2007, partly due to ranchers liquidating herds, have translated into ample beef supplies for the first half of 2008. However, feedlot placements are now declining and will continue to do so through spring. The April U.S. Department of Agriculture cattle report showed March new placements down 11 percent from a year ago and total feedlot inventories shrinking from 2.2 percent to just 0.3 percent above last year. As a result, beef supplies will be tighter for the second half of 2008. After gaining about 2 percent in the first half of the year, beef output could decline by i percent in the second half.

Seasonally, the "big three" grilling holidays of Memorial Day, May 26, Father's Day, June 15, and July 4 are upon us, and spring middle-meat prices have finally sprung. Prices for most steak cuts gained sharply in April and were at or near seasonal highs in May. Look for prices to settle back in July as seasonal demand slows.

Coffee--Futures prices dropped from highs in the mid-$1.60s in early March to the $1.30 range for April to May. We are looking ahead to slower summer consumption, a weakening U.S. economy and a big, upcoming Brazilian crop for 2008-09. Also, a recent trend toward mild winters --could this be the effect of global warming?--likely will limit the possibility of crop damage during the Brazilian winter, which occurs in July and August.

Dairy--Milk production is forecast to rise 2.4 percent in 2008. However, lower profit margins will lead to tighter supplies later in the year. The USDA now expects cheese prices to be higher in 2008. Block cheese is expected to average $1.80 in 2008, up 3.5 percent from $1.74 in 2007. Butter is projected to average $1.35 for the year, just above 2007's $1.34. Year-over-year declines are still expected for nonfat dry milk and whey.

Grain--Cold, wet weather has delayed corn planting so far this season. That could lead to a late-maturing crop that would be more exposed to damaging, midsummer heat during pollination, as well as more susceptible to frost damage come fall. Those factors could further reduce corn yield in a year when farmers are already projected to cut acreage by 8 percent. In its April Supply & Demand Report, the USDA slashed 2007-08 corn-ending stocks by 10.8 percent because of higher projected exports. Corn futures hit record highs of $6.06 per bushel in April and continue to trade in the $6 range.

Chicago wheat futures, which peaked at a record high of $12.70 per bushel in mid-March, plummeted to the $8 range in early May. Responding to high prices, global wheat output looks to increase by 8 percent in 200809. On the flip side, 2007-08 U.S. wheat exports will jump to 1.27 billion bushels, up 40 percent from a year ago and representing 62 percent of total U.S. wheat production. Exports and tight global supplies should put a floor under U.S. wheat prices for the balance of the year, and summer weather remains a huge wild card.

Rough rice futures doubled over the past six months, hitting highs near $24 per hundredweight in late April before backing off to the $20 range in early May. The rice rally began last fall when flooding in Vietnam and the Philippines limited available supplies. This year major producers like Egypt, Brazil, India and Vietnam curbed export sales to ensure adequate domestic supplies. That left the United States as one of the last remaining global suppliers. Strong global demand will push 2008 U.S. exports to 23 percent above a year ago. U.S. 2007-08 rice-ending stocks are projected to be down 45 percent from last year and the lowest since 1980-81.