The current state of the economy has been a topic of concern for much of 2022. And to some degree, rightly so. It has been no secret that living costs have increased throughout the year, with consumers experiencing inflation levels not seen in over 40 years. Fear of recession continues as consumer sentiment hovered around all-time lows for much of the year. Despite the negative attitudes around the market, the economy has been resilient on the labor front, recording low unemployment figures.

Within this short analysis, we will investigate the correlation between the inflation rate and the unemployment rate – known as the Phillips curve – and what it would mean to the protein market if the economy entered a period of stagflation (known as a period in time with declining economic growth, high unemployment, and high inflation).

As mentioned, inflation has hovered around multi-decade highs for much of the year. From a year-to-date perspective, the economy has averaged a 12-month rate increase of 8.1 percent for all items and 6.2 percent for core (this refers to all items less food and energy – volatile components of the consumer price index). Concerning food, the index for food away from home and food at home increased by 8.5 percent and 12 percent, respectively, from November 2021 to November 2022. The index for meats, poultry, seafood, and eggs increased 6.7 percent year over year.

Since the middle of 2022, inflation has decelerated, especially in the meats, poultry, seafood, and eggs complex. The index reached a year-over-year increase of 14.4 percent in April earlier this year. Despite the slowing rates, inflation remains a crucial issue, as rates have remained persistently high.
 

Regarding employment, analysts and economists have an overwhelming consensus that the current state of the labor market is strong. The most recent employment figures released on January 6th concluded that the unemployment rate in December 2022 sits approximately 10 percent below year-ago levels. Labor participation has been strong, especially for prime-aged workers (the working population between the ages of 25 and 54) – averaging 82.5 percent in 2022. The economy has continued to post job openings and new hires throughout 2022. The US economy averaged nearly 6.4 million new hires and 11.1 million job openings monthly from January to November.

 

The Phillips curve, a macroeconomic theory, indicates that inflation and unemployment typically have an inverse relationship. In other words, periods with high unemployment typically experience low inflation, and periods with low unemployment typically experience times of high inflation. Something that we have witnessed throughout 2022. However, the theory considers inflation expectations, and if these remain persistently high, the economy will return to its “natural rate of unemployment” –increasing unemployment—while price levels remain relatively high. Yet, it is crucial to understand that the theory hasn’t always held up.

 In the late 1990s, the US economy experienced low unemployment and low inflation. Such a contradiction was partly due to the collapse of the Soviet Union and technological advancements with computers and the internet, which boosted productivity. During the 1970s, the US economy experienced something very different; which brings us back to stagflation. Of course, there are many arguments for why stagflation occurred. Still, many would agree that the supply shocks in the oil market earlier in the decade helped drive prices upward, in addition to the increased budget deficit and the devaluation of the dollar, among many others, causing an increase in the overall cost of living. This situation hindered demand for other products, negatively impacting the economy and resulting in overall high levels of unemployment. Stagflation is a situation that fiscal and monetary policymakers want to avoid at all costs since it is painful and could take a long time to correct.

Within the last couple of years, the US economy has experienced several shocks – from the pandemic causing economic shutdowns to the Russia-Ukraine war impacting global energy and food prices.

The market continues to expect elevated levels of inflation throughout 2023. In a recent empirical survey, nearly 60 percent of all food industry participants believed inflation would remain between 4 and 6 percent by the end of 2023. At the same time, approximately 18 percent of participants expect inflation to be over 6 percent by the end of next year. These expectations hold significant value in understanding that many believe high inflation levels may be sticking around for some time. Since inflation expectations play a crucial part in the Phillips curve, this recent survey suggests many in the food industry believe relatively high prices will remain.

However, if high inflation levels persist and unemployment rise, we could witness a stagflationary period in the economy. Yet, we are not assuming the economy will enter stagflation—at least not yet—because inflation has been moderating by many measures while unemployment remains low. But the real question is: How might the protein commodity markets react during this time?

To dissect this, we must understand the obvious. The period post-inception of the pandemic has been a time that humanity has never before witnessed. Many bunkered in at home with their families and loved ones – voluntarily and involuntarily – as a result of the virus and lockdowns. Consumer spending on travel, entertainment, and dining out contracted significantly. Spending quickly shifted, and people began eating at home, experimenting and expanding their pallets. As a result, demand increased for high-priced cuts and trimmings (ribeye steaks, filet mignon, salmon, etc.) Prices for many reached all-time highs as a result of increased demand. Despite the persistent inflation and some correction, prices for many higher-priced items continue to hover at or around all-time seasonal highs.

Suppose the economy were to enter a period of high unemployment and inflation. If so, fundamentals suggest an increase for lower-priced items holding all other variables constant. Currently, many of these protein markets are dealing with disease complications and, as such, putting upward pressure on prices due to sporadic supply shocks. The US pork industry has been dealing with disease issues for some time with Actinobacillus Pleuropneumonia (APP), Porcine Epidemic Diarrhea Virus (PEDv), and Porcine Reproductive and Respiratory Syndrome (PRRS). On a macro level, the industry has had issues with African Swine Fever (ASF). The poultry industry has been dealing with the re-emergence of Highly Pathogenic Avian Influenza (HPAI). Although not affecting the broiler market, the egg and turkey markets have been experiencing upward pricing pressure due to increased infections.

If consumers were to make the switch to lower-priced proteins in an environment where supply is already affected by disease complications, prices could increase even further. The challenging part is how much. High prices cure high prices in the long run. But in the short run, we could witness cash-strapped consumers making more immediate substitutions – possibly lower-priced beef cuts, chicken products, or other seafood options. Demand destruction as a result of increased prices should never be counted out – even for the lower-priced protein commodities.

Currently, consumers have some excess savings to combat the increases in the cost of living. These were built during the pandemic. The amount of excess savings is still argued by many analysts and economists. Overall we have seen rapid wage growth since the inception of the pandemic, especially by the bottom quartile. However, the wage growth during this time hasn’t always been consistent with the growth of inflation. The bottom quartile spends a larger proportion of its income on food and shelter than the other quartiles. They may have extracted all their excess savings already – making this hypothetical scenario even more challenging to analyze.  

Photo Credit: SERSOLL / Shutterstock.com

Andrei Rjedkin
Urner Barry
1-732-240-5330 ext 293
arjedkin@urnerbarry.com 

Angel Rubio
Urner Barry
1-732-240-5330
arubio@urnerbarry.com