Canada Markets

As we considered in the Nov. 4 blog (https://www.dtnpf.com/…), the two most likely motivations behind investors demanding a higher rate of return are inflation-related (present or future inflation) or risk-related (election or United States debt level).

Developments following that publication suggest we may need to brush up on our 1970s inflation cycle history lesson -- including the fallout from what it took to halt the advance.

We've already recognized that current inflation is stable and close to the 2% Federal Reserve target with no signs of acceleration like it did in 2021. So much so that the Federal Open Market Committee (FOMC) in the U.S. had enough confidence to cut a further quarter point on Nov. 7. That marks a 3/4% reduction in the overnight Fed Funds target rate at a time when the U.S. 10-year note rose from 3.64% to over 4.30%.

Future inflation certainly appears to be shaping up as a likely explanation, given the campaign promises from President-elect Donald Trump. Between reduced taxes and increased tariffs, the impacts are widely expected to be inflationary. Add to that, central banks worldwide cutting interest rates due to concerns about local economies or labor developments play right into a repeat of the 1970s cycle.

Regarding risks -- we can rule out the election. A clearer winner could not have been declared, and concerns about civil unrest and months of political uncertainty no longer remain as a possibility. Orderly governance is expected to carry on.

The much more sinister long-term explanation would be that investors perceive risks associated with holding U.S. debt as being higher. That may well still be the issue given the campaign promises -- if fulfilled -- are estimated to add $10 trillion to the U.S. debt during the next 10 years. The implications of such a possibility were thoroughly covered in Nov. 4's blog, so we won't spend time on it here.

Recent developments do cast a shadow on the debt theory and are worth mentioning. Funds are raised through the sale of various duration Treasuries at auction. On Nov. 5, $52 billion in U.S. 10-year notes were sold followed by $25 billion in 30-year bonds on Nov. 6. The internal details of the auctions suggest there was excellent demand. Either the rate reached a high enough level that investors felt compensated for the debt risk, or debt risk was not actually the reason for the recent rise in rates.

Getting back to our other leading explanation -- the fear of future inflation increases mimicking the 1970s cycle. Looking at the accompanying graph, it's hard not to be concerned. An initial spike, with 2022 being somewhat lower than 1974, an initial taming, then (hopefully not in this case) a much more problematic surge into 1980.

If we do see an acceleration, it's hard to imagine food and energy not taking part. The greatest advances in taming the recent spike came through negative goods inflation, while it has been the services inflation that has been sticky and preventing a return to the 2% target.

The Oct. 30 blog (https://www.dtnpf.com/…) on crude oil laid out an increasingly possible scenario where Middle East tensions resulted in an energy price spike, given the low Strategic Petroleum Reserve levels. The latest media headlines about an Iranian-backed assassination plot targeting the president-elect already lays a foundation for retaliation of some sort, possibly carried out by Israel.

It doesn't take much of an imagination to see how food inflation could reignite. Looking at relatively tight supplies of global vegetable oils at a time of increasing demand and the resulting increase in price as of late are a perfect example.

The calendar doesn't help either. Inflation measurements are usually month-over-month or year-over-year comparisons. All you need for a positive rate is to be above year-ago levels (in the case of the latter). As we move through 2025, it won't be hard for most grains and oilseeds to exceed their 2024 counterparts.

So, what does that mean for management and marketing decisions? Refreshing your knowledge of 1970s history would be a good start. Be aware of the potential for increased prices when you develop marketing plans, and be on the lookout for triggers. It may also be wise to keep an open mind about prices increasing for no apparent reason as outside investors buy commodities as a hedge against inflation (more on that another day). And, unfortunately, consider the impact higher interest rates may have on the operation should a repeat of that part of the cycle be seen -- along with strategies on how to mitigate the impact.

Bringing the blogs together -- if rates continue to rise unexpectedly with poor economic reports and commodity weakness, debt risk is likely the issue, and consider the Nov. 4 discussion. If rates rise along with signs of a strong economy and better-than-expected increases in commodity prices, that 1970s inflation cycle might be the culprit. Then manage and market accordingly.

With that, keep in mind I'm always happy to get feedback along with any suggestions for future blogs.

Mitch Miller can be reached at mitchmiller.dtn@gmail.com

Follow him on social platform X @mgreymiller

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