COLUMN-Commodity prices likely to be hit by slowdown before end of 2023: Kemp

Rising commodity prices, energy shortages, capacity constraints in manufacturing, errors in demand forecasting and rising interest rates are themselves all potential triggers. CYCLICAL DURATION Since 1950, there have been at least 19 distinct troughs in the U.S. manufacturing activity index compiled by the Institute for Supply Management (https://tmsnrt.rs/3KNN2AW). Not all of these were declared official “recessions” by the U.S. National Bureau of Economic Research’s Business Cycle Dating Committee.

Prices for a wide range of commodities have climbed to their highest level for seven years or more as drillers, miners and farmers struggle to keep up with booming demand as the economy recovers from the pandemic.

Energy prices are at the highest level since 2014 while non-energy prices are the strongest since 2011, according to the World Bank (“Commodity prices – pink sheet data”, Jan. 5). Commodity prices have always been cyclical and recent increases will almost certainly create conditions for the next downturn, as they have in the past.

In theory, price escalation could be reversed by faster growth in production, slower growth in consumption, or some combination of the two. In practice, the most likely trigger is a slowdown in the global manufacturing cycle which causes commodity consumption growth to slow.

There are already signs the manufacturing cycle has passed an inflection point, with rapid growth in the wake of the pandemic and lockdowns giving way to moderate growth rates by the fourth quarter of 2021. Business surveys, industrial production estimates and freight movements all indicate the rate of expansion slowed in the second half of last year in North America, Europe and Asia.

Global manufacturing is likely to experience a significant mid-cycle slowdown if not an end-of-cycle recession by the middle of 2023. Rising commodity prices, energy shortages, capacity constraints in manufacturing, errors in demand forecasting and rising interest rates are themselves all potential triggers.

CYCLICAL DURATION Since 1950, there have been at least 19 distinct troughs in the U.S. manufacturing activity index compiled by the Institute for Supply Management (https://tmsnrt.rs/3KNN2AW).

Not all of these were declared official “recessions” by the U.S. National Bureau of Economic Research’s Business Cycle Dating Committee. Some were mid-cycle slowdowns, periods of softer growth in an otherwise uninterrupted expansion, but they were usually serious enough to force the U.S. central bank to cut interest rates or supply other stimulus.

The long relatively low-inflation expansions of the 1960s, 1990s and 2010s were all punctuated by one or more of these mid-cycle slowdowns. Mid-cycle slowdowns may have contributed to the long duration of these three exceptional expansions by temporarily easing emerging capacity constraints and inflationary pressures.

The average interval between ISM index troughs, whether recessions or mid-cycle slowdowns, has been around 37 months since 1980 or 39 months since 1950. The current expansion, which dates from April 2020, when most of the major economies were in lockdown during the first wave of the pandemic, is already almost 22 months old.

By the second or third quarter of 2023, the expansion will have reached the average duration for the arrival of a recession or slowdown. CYCLICAL FORECASTS

There has been considerable variation in the length of these manufacturing cycles, with a standard deviation around the average of 17-18 months. As a result, efforts to predict the timing of recessions have defied even the most experienced business-cycle researchers.

In the past, researchers have identified possible Kitchin cycles of 3-4 years attributed to inventory changes and Juglar cycles of 7-11 years attributed to investment in long-lived buildings and equipment. But while there is evidence of periodicity it is not sufficiently regular and stable to act as a reliable guide to business cycle forecasting (“Business cycles: theory, history, indicators and forecasting”, Zarnowitz, 1992).

Nonetheless, by mid-2023, the current expansion will be relatively mature, so any forecast for manufacturing activity and commodity consumption must include a significant probability of some sort of slowdown. It would be an error to project current levels and growth rates of commodity production and consumption forward through 2022, 2023 and 2024 without considering likely macroeconomic fluctuations in the interim.

Commodity prices and the macroeconomic cycle are inextricably linked. The current supply-chain problems and commodity-driven inflation are likely to sow the seeds of their own demise by making interest rate rises and a macroeconomic slowdown next year more likely. Related chartbook:

- Global economic indicators at the start of 2022: https://tmsnrt.rs/3rSSABB Related columns:

- Escalating U.S. inflation forces macro policy rethink (Reuters, Jan. 13) - Global economy faces biggest headwind from inflation (Reuters, Oct. 14) - John Kemp is a Reuters market analyst. The views expressed are his own (Editing by Jan Harvey)

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