Food inflation and QE2: the correlation is undeniable

Experts can argue all they want about the causality relationship between food inflation and the Federal Reserve’s second round of quantitative easing (QE2). What cannot be denied, however, is the correlation. Indeed, ever since QE2 was clearly signaled by the Fed, the price of food commodities surged.

There are at least three possible explanations. (The truth may be a combination of the three).

1. It’s a coincidence and there is no causality between food inflation and QE2. The rally in food commodities is due to poor harvests and rising global demand. Moreover, speculators and hoarders, in anticipation of these two trends, drove prices higher.

2. QE2 was expected to make the global economy better. This expectation lifted confidence, which sparked a recovery in the real economy and increased food demand. Speculators and hoarders may also have driven up food prices in anticipation of this boost.

3. QE2 was expected to flood the world with liquidity, devalue the dollar, and drive institutional investors out of U.S. Treasuries. In anticipation of this, institutional investors, speculators, and hoarders drove up the prices of food commodities.

QE2 was first signaled on September 21st and officially announced on November 3rd.

06/21/10 9/21/10 11/03/10 02/01/2011 % gained 9/21/10 to 02/01/11

Feeder Cattle 111.8 110.3 110.9 127.6 15.7 percent

Lean Hog 84.6 78.8 66.7 85.2 0.7 percent

Coffee 158.8 185.5 196.0 248.4 33.9 percent

F. Orange Juice 141.9 159.7 162.5 170.1 6.5 percent

Sugar 15.8 22.75 30.3 34.0 49.2 percent

Corn 354.3 504.8 579.0 666.3 32.0 percent

Soybean 963.0 1081.0 1238.5 1440.0 33.2 percent

Wheat 462.3 717.3 691.3 835.3 16.5 percent

Rough Rice 10.7 12.1 14.5 16.3 34.7 percent

As illustrated above, for most food commodities, rising prices coincided with the introduction of QE2.

One should note it makes sense that food commodities did not uniformly rise immediately after the announcement of QE2.

One, each is still affected by unique fundamental supply and demand factors.

Two, if speculators/hoarders did choose to bet on food commodities because of QE2, they are likely to favor select commodities at a time and then rotate into others at subsequent times.

A related point is that the varying impacts of QE2 manifest at different stages (e.g. at the signaling, announcement, first month of implementation, etc.), so the total effect doesn’t just happen at one particular time.

Email Hao Li at hao.li@ibtimes.com

Click here to follow the IBTIMES Global Markets page on Facebook.

Click here to read recent articles by Hao Li.