Bullish cotton investors may be losing a bit of their leverage on the market. At the beginning of the week, cotton futures for March were up. However, the big sell-off on Thursday, February 25, gave back all the gains made throughout the week. March 2021 cotton futures are down 3% at $0.8944. While May 2021 cotton futures are down 4% at $0.8969, and October is down 1.5% at $0.8792. Therefore, representing one of the biggest losses for the cotton futures market over the past month. But there remains an overwhelming sense of confidence on the market with Biden's $1.9 trillion dollar stimulus package, which may bring us even closer than anticipated with a vote scheduled in the house for this Friday.
The hope for the government stimulus, along with the ever-increasing rate of vaccinations in the U.S. and worldwide, is continuing to drive forward the idea that all quarters of 2021 will show economic improvement and growth. Adding to this speculation was the endorsement of the third vaccine, Johnson & Johnson, that is available for emergency use in the U.S. The Johnson & Johnson vaccine is a single-shot vaccine that could supply 100 million doses to the U.S. by summer's time. However, we must consider all this good news for the economy with possible side-effects of fast-paced economic growth.
When the economy grows as fast as its projections in the next year, this usually means inflation is not far behind. The risk of inflation must be taken seriously because of the amount of stimulus being pumped into the economy as it continues to recover at a rapid pace. Increasing employment, along with the drastically increased money supply in the U.S., is causing many investors to become growingly concerned about the threat of rising inflation rates that could be on the horizon in 2021. But how are cotton prices, along with other commodities, related or affected by the risk of inflation?
How are cotton and other commodities related to inflation?
One of the main reasons they are so interrelated is that commodity prices are often a leading indicator of inflation concerns. Commodity prices react much quicker than most products to shocks to the economy. For many different products, commodities offer a wide range of use throughout the economy as raw material. The way that inflation is often calculated is using a consumer price index (CPI), which measures inflation across the economy by checking if the prices for everyday items are rising or lowering. These everyday items are often necessities such as rent, utilities, food, and vehicle costs. As raw materials are often used in these products, commodity prices may provide an ahead-of-time view of the current state of inflation. However, when inflation rates do begin to rise, commodities are often where investors turn to hedge against it. When inflation becomes rampant, investors turn away from dividend-paying stocks because their value decreases as the dollar value decreases.
What is the current state of inflation?
Current fears of inflation were exacerbated this Thursday by the 10-year Treasury yields a 16-point increase to 1.614%. This puts it above the S&P 500’s dividend yield, which is currently sitting at about 1.43%. Therefore, indicating that growing inflation fears are causing yields to rise as people believe that dollar values will decrease and that higher yields make it worth buying bonds. Currently, CPI inflation projections are sitting at multi-year peaks of 2.2%, as compared to 0.47% at the onset of the COVID-19 pandemic.
To calm these inflation concerns, Jerome Powell, 16th chair of the Federal Reserve System, says that inflation rates should not be a concern as they are still low and that the central bank has the power to fight them if need be. Evidence shows that inflation will increase substantially compared to 2020 in 2021. However, there is no consensus among experts about how drastic these inflation rate increases will be. Regardless, investors and companies alike must be ready for elevated inflation rates in 2021.
Where are cotton prices headed?
In total, we can project that the coupled effects of increasing inflation, economic growth, and a bullish cotton market will continue to keep cotton prices elevated throughout 2021. As more and more investors turn to the commodity markets as inflation heats up, there will be increased demand driving up prices. The setback experienced Thursday, February 25, across the board for commodity prices and cotton futures may have been the first sign in months that we may be reaching the peak of cotton and commodity prices in their current elevated state.
As evidenced by lower prices in later months, investors seem to think that cotton prices will remain high in the short-term yet possibly stabilize or drop near the end of 2021. Anyone in the cotton or textile industry needs to keep a close eye on inflation projections and bond yields in the coming days as months. The increases may signal that prices could be elevated even further in the short-term. Using an exponential model with an alpha level of 0.5, we can show our current projections for where some of these future markets may head in the short-term.
Figure 1. The expected future market price of cotton by March 2021.
Figure 2. The expected future market price of cotton by May 2021.
Figure 3. The expected future market price of cotton by October 2021.
With only a slight decrease in projected prices in March, our projections show that we are holding our predicted cotton prices very similar to where they were last week. February 25's setback affects our model somewhat more than most because our elevated alpha level weights more than previous actual data points. We use this strategy in our model because of increased volatility in the market overall at the current time. Overall, cotton and textile companies should continue to expect elevated prices in 2021. They should also keep an eye on inflation rates in the coming days and months.