Global Economy Outlook – Commodity, Inflation and Advanced Nations

Abstract

Commodity price is one of the biggest concerns when Fed increases interest rate. Commodity price effects on inflation rate, which can potentially influence over consumption and corporation earnings. Throughout the report, we will address what caused decline in commodity price, and how it has effect on inflation rate.

Inflation on Economic Outlook

Advanced nations have suffered from low inflation. Low inflation could be beneficial for consumers since it provides lower price of goods, not for our economy today. Appropriate level of interest rate stimulates consumption, which boosts net income of firms. It, then, leads to increase in investment and creation of jobs. Inflation is helpful sometimes.

Figure 1 U.S. Inflation rate (red) and personal consumption expenditure (blue). They started declining together after 2014. Source: FED

After the great recession from December 2007 to June 2009, Fed conducted quantitative easing, which purchased $3.5 trillion worth of securities with zero-bound interest rate, to achieve 2% inflation rate. U.S. achieved on June 2014, but it started falling afterward. Inflation rate on September 2015 came out around -0.02%. Fed missed its target (Figure 1).

Quantitative easing restored its economy that U.S. GDP growth rate bounced back to pre-crisis level of 4% in Q3 2015 (Figure 2). But it costed a lot; debt held by Fed increased from 3.0% to 15.2% last 8 years (Figure 2).

It means that U.S. now needs to reduce its debt by increasing its interest rate and cutting government spending. Yet Fed cannot increase interest rate without inflation rate hike since it can contract U.S. economy.

Figure 2 U.S. GDP (blue, left) has been increased to pre-crisis level of 4% in Q3 2015. However, percentage of Federal Debt by GDP increased from 3.21% in Q3 2008 to 15.85% in Q1 2015.

Source: FRED

Cause of Low Inflation

Low commodity price dragged down inflation rate. As commodity price decreases, producer cost declines that firms are unwilling to increase their price. It is resulted in stagnated inflation rate.

Commodity price declined as world economy slowed down. IMF World Economic Outlook (Figure 3), for example, cut that global economic growth rate by 0.1%.

Especially Commodity of Independent States excluding Russia declined its growth rate by 0.4%. As Advanced Economics growth rate slows down, demand of goods from China declines. It leads to decline in commodity exports from developing nations since China is the largest commodity consumer in the world.

Figure 3 IMF Economic Outlook Projection for advanced and emerging nations. Growth rate in advanced nations started to decline in Oct. 2014, and emerging nations declined in Jan. 2015 projection.

Crude oil price stayed around $100 in mid-20014 because market participants expected higher oil demand coming from global growth; there was a bubble in the price. As price was skyrocketing, energy industry expanded its investment to increase supply.

As expectation faded away in October 2014, however, oil price fell down (Figure 4). It hurts global economics that hurts investment and labor market.

Figure 4 GreeHaven Commodity Index is a commodity index that weights 17 different commodities with the same weight. S&P GSCI Commodity Index is a commodity index that has 79% weight of energy sector. GreenHaven declined by 18.53% while S&P GSCI decreased by 39.29% from October 2014 to October 2015. Source: Yahoo Finance

Influence over Investment and Quality of Job

As economy slows down and expected profit declined, firms started to decline investment and wage (Figure 5). It resulted in interest rate hike issue and U.S. economic growth. FOMC released statement on September that they decided to maintain 0~0.25% interest rate due to low commodity price and inflation, and concerns over quality of jobs in labor market.

Despite unemployment rate declined to full-unemployment level of 5.1% in Sep. 2015, quality of job is continuously declined after commodity price decreased. From 2.4% in Q1 2014, average hourly earnings for workers started to decline to 1.9% in Q2 2015 (Figure 5). Along with personal expenditure spending (Figure 1), it gives a concern over consumption that takes around 70% of U.S. GDP.

It is resulted in stagnated corporate investment. Level of investment is stagnated since Q1 2013 (Figure 5). Despite it continuously shows positive growth rate, it is still below pre-crisis level. It is mainly caused by slow in consumption and rise in inventory level that companies are unwilling to expand their plant investment further.

Figure 5 U.S. Fixed capital formation (blue, left) and average hourly earnings (red, right).
Source: FED

Conclusion

Advanced nations stimulated their economy through quantitative easing. It provides high liquidity in the market, boosts inflation, improves labor markets and increases corporative investment spending.

It worked well until Q2 2014 where commodity price started falling down. With slowing global economic growth and low inflation rate caused by commodity price, quality of job declined, spending on investment stagnated, and consumption decreased.

At the same time, U.S., especially, debt on GDP increased by approximately five times. It will give more pressure for advanced nations’ debt, and potentially influence over economic growth.