Correlation of raw materials with inflation

One of the keys to understanding the economy and its dynamics is the correlation between raw materials and inflation. This link between the prices of natural resources, such as oil, metals and food, and inflation levels in an economy, has a significant impact on the daily lives of people and the economic strategies of governments and companies. In this article we will explore how the dollar influences the correlation of commodities and inflation, factors that influence the correlation, and the types of effects they have on the economy.

How the US dollar influences this correlation

The correlation between import prices and the US dollar is reflected in the downward trend of commodity prices when the dollar strengthens. Commodity markets trade in US dollars, so it may seem intuitive that when the dollar goes up, commodity prices go down. Simply put, a stronger US dollar will impact inflation through commodity prices and not consumer goods. Thus, a key factor to take into account to anticipate how the dollar will affect inflation is the behavior of raw material prices. However, import prices for consumer discretionary goods do not always move in sync with changes in the US dollar, as foreign companies often choose to maintain their prices in the US market.

Factors that influence the correlation between raw materials and inflation

1. Offer and demand: Commodity prices are largely influenced by supply and demand factors. When demand for raw materials increases, prices tend to rise, and when it decreases, prices tend to fall. Changes in supply, such as production disruptions due to natural events or geopolitical conflicts, can also affect prices.

2. Effects of inflation on raw materials: When inflation increases, production costs tend to increase, which can lead to an increase in the prices of raw materials used in production. For example, an increase in oil prices can lead to an increase in the costs of transportation and production of goods and services, which in turn can result in higher prices for consumers.

3. Shelter against inflation: Some people and companies see commodities as a hedge against inflation. This means that when they expect inflation to rise, they can invest in commodities to protect their wealth, since commodity prices can rise in response to inflation.
4. Cyclical behavior: The relationship between commodities and inflation can be cyclical. In some cases, an increase in commodity prices can fuel inflation, and vice versa. However, this relationship is not always linear or constant, since other economic and political factors can also influence prices.

Effects on the economy of the correlation of raw materials and inflation

Unique effect: 

Commodity prices are considered to be a leading indicator of inflation through two basic channels:

• Leading indicators often show measurable economic changes before the economy as a whole does so. Commodity prices respond quickly to general economic shocks, such as increases in demand.
• Price changes reflect systemic shocks, such as hurricanes, that can decimate the supply of agricultural products and subsequently increase supply costs. By the time it reaches consumers, global prices will have increased and inflation will have occurred. The strongest argument for commodity prices being a leading indicator of expected inflation is that commodities respond quickly to widespread economic shocks.

Transmission effect:

In the past, increases in oil prices were behind a sharp increase in the prices of goods and services. The reason is that oil is a fundamental input to the economy and is used in critical activities such as heating homes and fueling cars. If the price of oil increases, the cost of manufacturing plastics, synthetic materials or chemicals will also rise and will affect consumers. This correlation has been evident during the past year 2022 with the increase in costs derived from the war in Ukraine.

Variable effect:

Commodity inflation movements depend on what is driving the commodity change. Additionally, a stronger dollar in the global market will increase the price of commodities relative to foreign currencies. The increase in the price of raw materials in foreign currencies will decrease the demand and price of raw materials in dollars. In this scenario, rising commodity prices abroad could lead to domestic deflation.