When forecasting markets, it is easy to forget to take our noses out of supply and demand reports and look around for policy developments that could alter market dynamics.
One such development jumped up and bit commodity markets Nov. 12 when China reported that inflation rose to 4.4 percent in October, the highest in more than two years.
Markets expect China’s government to shift its policy emphasis from stimulus to keep the economy humming while the United States and much of the developed world struggles out of recession, to an anti-inflation stance that will increase interest rates and tighten money supply to cool an overheated economy.
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However, a cooler Chinese economy would need fewer raw materials, and that knocked down the price of metals, oil and crops.
Prices partly bounced back on the next trading day, Nov. 15, but investors will nervously monitor developments in China and vigorously react if Beijing launches a blunt, full scale war against inflation.
For now, many believe it will act in a more sensitive and targeted manner, partly because the main culprit behind rising inflation in China is higher food prices, which are up 10 percent over last year.
Traditional inflation controls such as higher interest rates tend not to reduce the demand for essentials such as food.
Longer term, Beijing will continue to look for ways to stimulate greater food production, but in the short term, food subsidies or food price controls might be more effective in taming inflation.
Either way, it seems unlikely that the government would try to limit food imports because that would only further tighten supply and drive prices higher.
Another thing that might prevent China from over reacting to inflation is that inflation in the rest of the economy grew only modestly and there are signs that economic activity such as steel making has slowed in recent weeks.
Indeed, the Baltic Dry Index, which gauges the cost of ocean shipping commodities such as iron ore, cement, grain, coal and fertilizer, is down about 13 percent since the end of October.
Many of these commodities go to China.
However, the picture delivered by the BDI is a bit blurred by the fact that a large number of ships have come into service in the last year, so new shipping supply is also at work in lowering the index.
Another policy matter to keep an eye on is the 45 cent per gallon ethanol blenders tax credit in the United States, which is set to expire at the end of the year. The credit is an agricultural issue because 38 percent of the U.S. corn crop is used to make ethanol.
Normally, ethanol tax breaks have strong support in Congress. However, the ballooning deficit has become a key political issue and the rising power of the fiscally conservative Republican Tea Party movement means the tax credit may not be extended.
The mandate to blend ethanol with gasoline is the most important policy supporting ethanol development in the U.S.
However, the blenders’ credit, which is applied on a volume basis without regard to the profitability of ethanol production, is said to be the reason why the industry is growing faster than needed to meet the mandate.
I doubt Congress will end the tax credit, given the political importance of ethanol production to the Midwest, but there is speculation that it will be modified so that it varies with industry profitability.
Such a modification would not likely make a big difference to ethanol production and therefore corn demand, but corn prices would likely drop if members of Congress show surprising backbone and eliminate the credit.
