In its most recent update, the International Monetary Fund projected global growth to slow sharply, from 6.1% in 2021, to 3.2% in 2022 and 2.9% in 2023. Slower growth means lower demand for commodities, and hence lower prices.
Moreover, as the US Federal Reserve and other central banks tighten monetary policy, real interest rates are likely to rise. This will probably push down commodity prices, and not just because high real interest rates make a recession more likely. The level of real interest rates affects commodity prices independently of GDP, both in theory and empirically.
The theory of the relationship between real interest rates and commodity prices is long-established. The simplest intuition behind the relationship is that the interest rate is a “cost of carrying” inventories. An increase in the interest rate reduces firms’ demand for holding inventories and therefore lowers the commodity price.
Three other mechanisms operate, in addition to inventories. First, for an exhaustible resource, a rise in the interest rate increases the incentive to extract today and thus expand the available supply. Second, for “financialized” commodities, an increase in the interest rate encourages institutional investors to shift out of the commodities asset class and into Treasury bills. Lastly, for a commodity that is internationally traded, an increase in the domestic real interest rate causes a real appreciation of the domestic currency, which works to lower the domestic-currency price of the commodity.
Econometric analyses have demonstrated the statistical relationship between real interest rates and commodity prices. These include simple correlations; regressions that control for other important determinants, such as GDP and inventories in a “carry trade” model; and high-frequency event studies that are much less sensitive to the econometric problems of the regressions.
Two episodes illustrate that the effect of real interest rates on commodity prices operates independently of the GDP effect. Neither the spike in dollar commodity prices in the first half of 2008 nor the decline in 2014-15 can be explained by fluctuations in economic activity. They can instead be interpreted as the result, respectively, of loose US monetary policy (quantitative easing) and a tightening of US monetary policy with the end of QE.
Real interest rates appear to be on a firm upward trend, because nominal interest rates will rise, and inflation will fall. Together with decelerating global growth, that could mean that the recent decline in real prices of oil, minerals, and agricultural products will persist.
Jeffrey Frankel, professor of capital formation and growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the U.S. National Bureau of Economic Research.