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April 6, 1 979 Food- U p 1 0 Percent? The U.S. Department of Agriculture (U SDA) has the greatest concentration of agricultural expertise in the world. When such an organization gears up to forecast food prices, people pay close attention. Thus, last November when U SD A told us that 1979 food prices were likely to average 7.5 percent over the 1978 level, there was little dissension. But today, just four months later, you would be hard put to find a single soul willing to put money on such an optimistic forecast. In 1979 as in 1978, unexpected agricultural developments have caught U SD A with its forecasts down. sion for the bottom line and quickly decided to limit output. The severe winter of 1978 also increased mortality rates and slowed weight gains, so by the time the year was out, pork production had expanded by only 1 percent - rather than the anticipated 10 percent. With the pigs not coming to market, beef prices shot through the roof. Add to this the impact of the Florida freeze and the inopportune California rains on fruit and vegetable harvests, and the result was a 10-percent increase in food prices for the precisely double the initial U SD A forecast. The treacherousness of food-price forecasting is easily illustrated by a review of 1978 developments. In November 1977 (November is the month in which the fi rst forecast for the com i ng year is made), U SDA said 1978 food prices would probably average 4 to 6 percent over the previous year. No one knew better than U SDA that we were moving into the trough of the cattle cycle - that beef production would be down and that beef prices wou Id be pushed upward. But USDA expected only a moderate increase in beef prices, because the nation's hog farmers had said that they intended to expand pork production by 10 percent in 1978. Since many consumers switch from beef to pork when the former becomes too expensive, U SD A feltthat cheap and plentiful pork would dampen demand for beef and hold beef-price increases to modest levels. Problemson the farm While the country's hogs were quite willing to cooperate with the necessary procreation, hog farmers saw the implications of their collective dec i- Having eaten their collective hat along with most other price forecasters - the world's largest Agriculture Department sat down again last November with pen, paper and computer to churn out a forecast for 1979. To increase the probability of being correct, U SD A considerably widened the forecast range and predicted that 1979 food prices would average 6 to 10 percent above the 1978 level. The most likely scenario, the forecasters said, would be a 7.S-percent increase forthe year - which translates into roughly a S.S-percent year-end to year-end increase for those of you who keep score that way. As things are turning out, that 7.5percent forecast will considerably understate the actual increase, and the 1 O-percent top-of-the-range figure may just barely capture the final outcome. Implicit in the 7 .S-percent forecast is an assumption that prices down on the farm will average only 7 percent higher in 1979. Well, the January and (continued on page 2) F2brLJar'y'inCr2LlS25 '/v'2re 50 IZlrgethtit, even iffarm prices remained unchanged for the rest of the year, their annual average wou Id be double the USDA assumption. Thus, the recent upsurge in farm prices by itselfwould push the food-price forecast above 9 percent, and any further price increases in the field will only add to this figure. Problems off the farm Food buyers frequently forget that the bulk of what they pay at the supermarket check-out counter - that is, almost 60 percent - goes to pay for things done to food after it leaves the farm gate. Any forecast of food prices must obviously take account of potential developments in this marketing sector, where food gets transported, stored, processed, advertised, packaged and sold. This year, USD A may have understated both the labor and energy components of the marketing bill. Last November, U SD A projected an 8-percent increase in labor costs, which accouni for about halfof all marketing costs. A substantial share of the unionized food workers will renegotiate contracts during 1979. (While only 20 percent of food-industry workers belong to unions, union wage settlements tend to influence nonunion wages.) In view ofthe recent rise in forecasts of the overall rate of inflation, and in view of union leaders' perception of the huge fourth-quarter profits increases, average wage increases this year may be closer to 10 than to 8 percent. 2 The second untoward development in the marketing sector was OPEC's announcement of a 1 4. S-percent increase in oil prices, followed closely by an interruption in Iranian oil supplies. It now appears that energy costs will rise significantly in 1979, which will in turn raise the costs of transportation, packaging and processing. Reflecting all these developments, the increase in marketing costs will probably be closer to 8.5 percent than the assumed in the U SD A forecast. Altogether, the recent farm-price upsurge would add 1 .6 percentage points to the original 7. S-percent U SD A forecast, and the extra marketing costs would add 0.9 percent more. Thus, it seems likelythatwewill be paying roughly 10 percent more for food in1 979 than we did last year. And of course, any further leap in farm prices will push the consumer price even higher. Room for hope There are signs of farm price moderation on the horizon, however. The main reason for this lies in the livestock sector, wh ich has been responsible for much of the worsened price pictu re of the past year. When we look at the number of cattle in the pipeI ine, we might assume that the tightest supply situation and the biggest price jumps would occur this spring and summer. However, market participants may have begun to stock up in anticipation ofthis rise in prices. Thus, the amou nt of beef in cold storage has been growing very rapidly since last September, and early last month stood about a third higher than the year-ago level. Anticipatory buying thus caused ________________________________ ____ 1 FOOD PRICE CHANGES 10 1950 prices to rise ear! ier than expected, so that, come spring and summer, these high-priced cattle shouldn't be selling for much more than they are now. Actually, the futures market suggests that live cattle prices will decline by 8 percent between now and December. In add ition, Iast week's hog report confi rmed that the pigs wi II indeed be coming to market this year. On March 1, there were 12 percent more pigs being held for slaughter and 20 percent more held for breeding, than a year ago. Furthermore, there will be 24 percent more baby pigs entering the world during the second quarter of this year than in the same period of 1978. Add to this a 9-percent increase in broiler production and a 20-percent increase in turkey production, and you have a plentiful supply of beef substitutes that shou Id keep the Iid on beef prices once the recent cattle price increases work their way through the marketing chain. A caveat to consumers: our current position in the cattle cycle suggests that prices will continue their ascent after this nearterm moderation, and that we won't experience any serious price relief until the early 1980's. What about other farm prices? Good wheat crops in Australia, Argentina, Western Europe and the Soviet Union, plus record inventories in this country, suggest a relatively flat trend of prices over the rest of the year. A Brazi Iian drought, leading to an estimated 20percent reduction in that country's soybean crop, may continue to strengthen U.S. prices for another month or so, but our record stocks and expected record plantings this spring 3 suggest an. e\/entuJ! softenin. b in soybean prices. (The futures market seesa 9-percent drop in soybean prices between July and November). On the vegetable scene, winter acreage is up, so that adequate suppl ies shou Id prevent any untoward price movements. A citrus shortage has driven up the prices of all fruits, and while there is no evidence that grower prices wi II weaken, it is also not clear that they wi II rise any further than they already have. Risingbottom line The bottom line is thatfarm prices have probably blown off most of their steam for the year, and any further increases may be rather moderate. But since it takes several months for farm prices to work their way through the pipel ine, we can expect that food prices will continue to be th,e villain in the monthly CPI reports probably through the end of spring. Reflecting all these developments" U SD A recently raised its food-price forecast for the year from 7.5 percent to 8.5 percent. However, even this forecast may be conservative, because it implies that average increases forthe remainder of the year will be on the order of only 0.3 percent per month. In view of the farm-price increases to date, as well as the above-mentioned developments in the marketing sector, this forecast may be outpaced by reality, Thus, U SD A may be forced to move its forecast closer to 10 percent as the year progresses. Michael Gorham uOl?jU!4st?M"4t?ln " uo?jaJO" t?pt?J\ai'j" o4t?PI !!t?Mt?H "t?!UJOJ!lt?:) t?uozpV t?>jSt?IV Y:0) Jr \li(,,®C£ 'J!I1!'j 'o:)sput!'J:!lU1!'S l:SL:'ON a'\'«1 : J9\flS Od 's'n llVW 55Vl:> BANKING DATA-TWlELfTH FEDERAL RESERVE DISTRICT (Dollaramountsin millions) SelectedAssetsand liabilities LargeCommercialBanks Amount Outstanding 3/21/79 122,496 100,148 29,144 35,689 20,580 1,607 7,740 14,608 38,881 28,681 29,720 50,275 40,738 17,941 Weekended 3/21/79 Change from 3/14/79 936 943 168 99 Changefrom yearago@ Dollar Percent NA NA Loans(gross,adjusted)aridinvestments* Loans(gross,adjusted)- total# Commercialand industrial Realestate 72 Loansto individuals Securitiesloans 34 U.s.Treasurysecurities* 4 Othersecurities* 3 1,312 Demanddeposits- total# Demanddeposits- adjusted 835 Savingsdeposits- total 98 Timedeposits- total# 138 Individuals,part.& corp. 220 (LargenegotiableCD's) 183 \AkeklyAverages Weekended Comparable year-agoperiod of Daily figures 3/14/79 MemberBankReservePosition ExcessReserves (+ )/Deficiency(-) 46 53 65 Borrowings 34 27 13 Netfreereserves(+ )/Netborrowed(- ) 80 26 52 FederalFunds- Sevenlarge Banks Net interbanktransactions + 1,620 + 869 + 432 [Purchases (+)/Sales(-)] 2 Net, U.s. Securitiesdealertransactions + + 110 + 315 [Loans(+ )/Borrowings(-)] * Excludestradingaccountsecurities. # Includesitemsnot shownseparately. @ Historicaldataarenot strictly comparabledueto changesin the reportingpanel;however,adjustments havebeenappliedto 1978 datato removeasmuchaspossiblethe effectsof the changesin coverage.In addition,for someitems,historicaldataare not availabledueto definitionalchanges. Editorialcommentsmaybe addressed to the editor (William Burke)or to the author.... Freecopiesof this andother FederalReservepublicationscan be obtainedby callingor writing the Public InformationSection,FederalReserveBankof SanFrancisco,P.O.Box 7702, SanFrancisco94120.Phone (415)544-2184.
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