Monetary Policy and Agricultural Commodity Prices: It’s All Relative

Historically, agricultural commodity prices tend to rise during periods of low real interest rates. For example, from 1940 to 1951, the producer price index for farm products rose 200% when real interest rates on 3-month treasuries were negative (Figure 1). A similar pattern emerged in the 1970s and more recently from 2005 to 2014. In fact, analyzing data from 1950 to 2005, Frankel (2006) found strong correlations between changes in real interest rates and agricultural commodity prices. The strongest relationships were in crop markets. Corn, wheat, soybean, and cotton prices fell 9.1%, 8.8%, 6.4%, and 6.1%, respectively, for every 1% increase in real interest rates. In contrast, cattle and hog prices fell 4.8% and 3.1%, respectively, for every 1% rise in real interest rates. Heading into 2018, a new pattern has begun to emerge. During the first few weeks of 2018, the spread between U.S. and international interest rates has narrowed. For example, the spread between the U.S. and German 10-year bonds had narrowed to 2.0 percentage points by the end of 2017, slightly less than the 2.4 percentage points in December 2016. In addition, after peaking in December 2016, the value of the dollar had declined roughly 7% against a broad set of U.S. currencies by the end of 2017. Heading into 2018, the impact of interest rates on agricultural commodity prices will depend on global monetary policy shifts and the spread between U.S. and international interest rates. More aggressive tightening in U.S. monetary policy compared to the rest of the world could lead to a wider interest rate spread, a stronger dollar, and weaker agricultural commodity prices. In contrast, less aggressive tightening in U.S. monetary policy could lead to a narrower interest rate spread, a weaker dollar, and support for higher agricultural commodity prices.