Editor's Note: Below is a note written by Hedgeye Junior Macro analyst Ryan Ricci and editor Eric Wallerstein.
Fertilizer just had a big deceleration – prices are down to +125% year-over-year vs. the previous +165%.
Why does that matter?
Fertilizer prices lead Food prices, which lead CPI-Food inflation (food leads CPI by roughly 2 months.)
Considering the general need for people to eat – the price of food is fairly important. But with regards to headline inflation, food represents 15.4% of the overall CPI basket – nothing to balk at.
So where is fertilizer heading? Down.
Since peaking on 11/26/2021, fertilizer prices are down -14%.
While the Fertilizer to Food correlation should square in your head, mathematically, there’s a 0.47 correlation between the two. There’s a range of other factors here (meatpacking supply chain dynamics, Covid & lockdowns, etc.), but fertilizer is clearly a key input for overall food prices.
So right now we’re at:
- Food prices are a not-so-inconsequential underlying component of headline inflation
- Fertilizer prices front-run food … and fertilizer is headed lower
Pretty basic; first-order stuff. How can we predict where Fertilizer prices are going and front-run the front-run? Natural Gas and Coal.
Natural gas and fertilizer have a 0.541 correlation, while the relationship between coal and fertilizer is very strong, at 0.716.
From its cycle peak, natural gas is down -33%. Coal saw a similar deceleration, down -29%. Natty and coal peaked on 10/27/21 and 10/12/21, respectively.
While the chart tells the story well on its own, here it is in words: fertilizer prices are dropping, and should continue to do so following natural gas and coal’s heavier declines. The result is lower food prices (a win for the American eater), and thus, downward pressure on headline inflation.
Ahead of Wednesday’s (1/12/22) CPI print, the Street, mainstream media, political parties, and essential everyone, are keen to see if inflation remains sticky or we disinflate from the peak. While the recent drop in fertilizer prices is not likely to flow through just yet, this should be a deflationary pressure as we head into the second quarter of 2022.
The Fed finally admitted to inflation’s lack of transitory-ness, and is considering/signaling/pretending that they’re willing to drop their olive branch and get hawkish. But if we get strong deceleration on the Wednesday’s print (1/12/22), Powell will be left with a choice: hike into a slowdown and tank the market or follow in his predecessors’ footsteps and keep the punch flowing.
Hiking would run the risk of repeating the fourth quarter of 2018; assuming Powell’s memory extends longer than a few years, will he really be willing to make the same mistake? The Magic 8 ball says, “Don’t count on it.”
Understanding where the underlying components are trending is critical to see where inflation is heading (and just slightly more important than a twitter thread talking about the Fed’s Dot Plot or supply chain narratives.)
With Wednesday's CPI print on the horizon (roughly 2 weeks before the January FOMC meeting) we'll have to see what the Fed decides. Regardless, medium-term trends, such as the relationship between energy, fertilizer, and Food-CPI, could pressure headline inflation downward over the coming months and quarters, leaving the Fed in a precarious situation.
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