Inflation has not gone unnoticed in the news lately; the global supply chain, labor market, and consumer demand environment are still in flux. Furthermore, inflation is not merely an economic issue for organizations working across country borders; It can be a critical economic factor with consequences for input costs, profit margins, and long-term planning.
Read also: What Rising Global Inflation Means for U.S. Businesses and Investors
One of the best early rising indicators concerning inflation is not necessarily found in the government reports but in the commodity futures markets. These forward-looking contracts exhibit expectations about current and future price movements in relation to supply and demand and can provide a good insight into where inflation levels may be headed to.
Inflation does not occur overnight. Well before consumer prices increase or central banks react, signs of underlying inflation will have started to appear in the markets that trade the world’s most critical goods. When you think of commodities, you might consider contracts for raw materials, like oil, copper, and wheat, because they often are the leading indicators in shifting expectations about future prices.
When these prices start to move, they not only represent the immediate supply and demand represented in the contracts, but they reflect what is coming next. For organizations with global exposure, it is critical that they know how to recognize those movements in order to stay ahead of net rising costs
The Link Between Inflation and Commodity Futures
Commodity futures markets provide a real-time gauge of expectations of inflation. Whereas traditional inflation measures—the Consumer Price Index (CPI) and Producer Price Index (PPI)—count backward in time when providing inflation data, futures prices produce data with a forward-looking perspective. Futures market participants aren’t just reacting to the current supply/demand dynamics of inputs, they’re thinking about future prices in terms of cost changes, monetary policy changes and, more generically, other actors in the global economy who may influence moves in prices in the future.
An obvious link between inflation and futures pricing is the “cost-push” link – the relationship between rising costs of inputs like energy, metals and agricultural goods, which will generally push prices throughout supply chains and generally into consumer prices as well.
Crude oil futures prices, for example, represent woodland, energy, and logistics cost impacts that include transportation impacts across all industries, meaning that if crude prices rise, it’s an early indicator of subsequent energy cost pressures. The futures prices of copper, like energy, are a widely used input into construction, electronics and manufacturing. Rising copper prices typically reflect either increasing copper anxiety—supply or demand—or cost pressure, but they also indicate an impending inflationary trend related to ongoing activity in the industrial economy.
Agricultural futures exhibit a similar function. Wheat, corn, and soybean contracts are especially influenced by variables such as weather, geopolitical risk, and changing consumption trends. When grain futures increase sharply, food production costs (animal feed to packaged goods) and both producer and consumer price indexes tend to follow suit.
Futures markets also tend to anticipate official inflation indicators weeks or months ahead of actual data. Traders position trades based on market forecasts, risk hedging, and macroeconomic indications to gain pricing and changing trends.
Therefore, commodity futures are one of the first and most responsive indicators of inflation expectations, which are used by institutional investors, central banks, and corporations, and can be used in future strategic decision making and assessment of future cost pressures.
Key Commodities as Inflation Indicators
There are a select few commodities that carry more weight with regard to signaling inflation. Crude oil, copper, wheat, and soybeans are leading symptoms of inflation from higher input costs from sectors such as manufacturing and construction through to food production and transportation.
The most highly watched of those products are crude oil futures. Energy backups nearly every element of the global economy, from freight and air travel to manufacturing and consumer goods, so it is often the case that crude oil price movements using crude oil futures will lead us in an inflationary direction. In fact, as forecasted rising input costs last year ahead of inflation reports published by developed economies, suggested that the spikes in crude futures in 2021 would manifest in future surging transportation and utility expenses in inflation readings.
Copper is the other significant benchmark. Often referred to as “Dr. Copper” because it could potentially diagnose the health of the global economy, copper’s widespread usage in construction, electronics, and renewable infrastructure make it a reliable barometer of the level of industrial demand.
For example, in 2021, during the global economy’s post pandemic recovery, copper futures spiked at the same time there were robust spending on infrastructure and supply chain disruptions, which also offered early indicators of cost pressures that would filter through, very quickly, to durable goods and manufacturing inputs.
With food inflation context, wheat and soybeans have been exceptional examples to understand. In the 2021-2022 period, futures prices for both commodities surged due to a combination of national scale droughts, export restrictions, and geopolitical uncertainties (long before the grocery store prices reflected the supply shocks). Futures markets allowed food producers, distributors, and retailers early opportunity to react to escalating costs.
Numerous global corporations do this when they observe commodity futures in their procurement and budgeting processes. In many cases, companies use commodity futures prices not as a lagging indicator, but as a leading indicator, which allows up front decisions – especially regarding inventory procurement, pricing, and nesting contract negotiations – in the face of inflation based cost increases.
How Inflation Expectations Affect Futures Market Behavior
Futures traders frequently adjust their positions based upon the changing rates of inflation expectations, not upon credit card rates. What does this mean? Well, inflation expectations affect the directionality of commodity prices and how traders position themselves across asset classes. Rise in inflation expectations often influences the traders to have increased long positions (exposure) to commodities viewed as inflation hedges (e.g. oil, metals, agricultural products), and reduces their position in assets more susceptible to a shock to their cost.
Interest rate expectations are considered the crux of this process. Futures markets react quickly to expected actions from central banks, especially the U.S. Federal Reserve. As inflation readings continue to show price advances, traders begin to price in tighter monetary policy – higher interest rates, which may stifle demand and affect commodity valuations. The convergence of expectations can lead to even more volatility as markets try and digest not only inflation but the policy response as well.
A related aspect of inflation-related volatility is that when price movements increase dramatically, the exchanges will increase margin requirements to account for increased risk, and this can restrict market access, especially for smaller traders, and constrain liquidity and, in the worst cases, create feedback loops of volatility. As volatility persists, do not be surprised when higher margin requirements produce a continuous cascade of margin calls that result in forced selling against a still volatile market.
Moreover, inflation, commodity futures, and currency markets are highly correlated. Generally, we should recognize that a precondition of inflation is a loss of purchasing power, which tends to be particularly poignant in terms of local currency valuations. The result of this dynamic is that inflation stimulates, and pushes, capital into dollar-denominated commodities at rates that exceed any fundamental instinct of an upward slipped price oscillation in futures contracts.
Lastly, for institutional players it is critically important to get a handle on these interdependencies. Inflation does not simply work on its own. It will impact future markets by way of monetary policy, emotional behavior, and flows of global capital that affect how traders make exposure and risk management decisions in an uncertain environment.
Strategic Use of Futures to Manage Inflation Risk
Commodity futures are important tools for protecting margins for many businesses, particularly ones with volatile input costs. Futures contracts allow firms to fix their price today for goods they will need in the future, providing a cost certainty that is critical in an inflationary environment.
Consider manufacturers. Manufacturers of products that contain metals like copper or aluminum often use futures contracts to hedge their price risk. By locking in a price in advance, they can eliminate the element of surprise in the price of copper and plan a better production budget. The same rationale applies to fuel. Commercial airlines and logistics businesses hedge their exposure to movements in the price of oil by using crude or diesel futures contracts. Airlines can find ways to stabilize their operating costs and help avoid on the day surges in jet fuel prices.
Futures are just as important in agriculture. Food producers routinely hedge their price risk associated with grains like wheat, corn, or soybean with futures contracts. In fact, companies that use grains to make food typically use futures contracts to hedge their exposure to price increases associated with crop shortfalls, export restrictions, bad weather, or other inconvenient surprises. This protection allows firms to keep their pricing fairly consistent in the market when these prices experience surges.
In addition, more businesses are including price adjustment clauses in their supply agreements, using delivery point futures prices as the benchmark. The contracts shift automatically with the market pressures—these contracts are transparent and it limits the need to negotiate new terms when inflation is on a ride with respect to the benchmark price.
And it is not only about fixing the price. Many procurement teams use outputs from futures markets to help guide their purchasing decisions. Finance departments monitor the futures curves to help manage their inflation outlooks and budget forecasting. The information from these blind markets, although often ignored outside of the trading arena, have become most valuable inputs to businesses to help get in front of yet to materialize cost pressures, instead of being reactive to cost rises and denying their needs after they happen.
Conclusion
While inflation can be complicated, the omens of inflation can often be found in plain sight—in the commodity futures markets. These markets provide an early indicator of cost pressures in energy, materials, and food from months ahead of when that pressure becomes visible in the official data.
For businesses with global operations, watching and interpreting futures prices is not only a trading strategy—it is a key component of risk mitigation. Company futures deliver both value when it comes to economies, but also timely information to guide company purchases, support financial numbers, and hedge against waiting to buy input costs.
While inflation continues to develop and present with the emerging shifting of monetary policy along with global supply chains, businesses that will properly interpret and visualise pricing in futures, will be ahead of the pack. In a world in which costs can escalate quickly and without warning, a little foresight is usually an advantage—commodity futures still deliver one of the most aggressive ways to anticipate cost trends and potential changes in input behaviours.
