Hidden Inflation: Food Prices Flying Under the Fed's Radar

Soaring food prices have been, perhaps, the most pressing global issue of the past two years – yet the U.S. Federal Reserve has taken a "hear no evil, see no evil, speak no evil" approach to the global crisis.

Instead, the Fed has dutifully maintained its focus on so called "core inflation" in the United States – even as Americans suffer the consequences of the "hidden inflation" the government refuses to account for.

The Federal Reserve excludes food and fuel prices from its preferred gauge of inflation because they are often influenced by erratic weather patterns and political turmoil. That at times has been the case over the past few years.

Droughts in Russia and floods in Australia, for instance have helped drive food prices to record highs. However, the Fed's monetary policy has also affected prices. The U.S. dollar has fallen substantially in the past three years, and the prices of agricultural commodities – which are priced in dollars – have reflected that decline. The result has been a chilling effect on consumers in local grocery stores and gas stations.

An 8.5% monthly gain in gasoline prices pushed the transportation costs up 2.3% in December, making it the driving force behind the consumer price index's 0.5% headline gain. Core inflation, which excludes food and energy prices, rose just 0.1%.

Oil prices rose 10.2% in the period from Nov. 1 to Dec. 31, as rising demand in emerging markets and a subservient greenback pushed the price of crude over $90 a barrel for the first time in two years.

U.S. food prices rose 0.1% in December following a 0.2% increase the month prior. Prices were up 1.5% for all of 2010, with meat and dairy products making the biggest jumps. Beef prices were up 6.1% in December 2010 compared with a year earlier, while pork prices jumped 11.2% last month compared with December 2009.

And food prices are poised to climb substantially higher in 2011, spiking 2% to 3%, according to the U.S. Department of Agriculture's Economic Research Service. That price jump will impact prices at grocery stores and restaurants.

For instance, a food basket survey by The Tennessean earlier this month found a 12.5% increase in prices for a typical grocery basket full of staples compared to November 2009. And McDonald's Corp. (NYSE: MCD) – the world's largest food chain – said yesterday (Tuesday) that it plans to raise prices this year to help offset an expected rise in its grocery bill for the 10 commodities that account for around 75% of its food preparation costs.

"As commodity and other cost pressures become more pronounced as we move throughout the year, we will likely increase prices to offset some but not necessarily all of these increases," said McDonald's Chief Financial Officer Peter Bensen.

The average price McDonald's pays for its most used ingredients – beef, chicken, cheese, and wheat – is expected to go up by 2-2.5% this year.

The restaurateur's major rival Yum! Brands Inc. (NYSE: YUM) and packaged food companies like Kraft Foods Inc. (NYSE: KFT) and Sara Lee Corp. (NYSE: SLE) are likely to see similar price increases.

Still, U.S. Federal Reserve Chairman Ben S. Bernanke insists that price pressures in the United States remain subdued.

"Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward," the FOMC said in a statement following its Dec. 14 meeting.

The FOMC today (Wednesday) will conclude its first two-day meeting of 2011, and likely announce no significant changes to its monetary policy.

"While the Fed may identify higher commodity prices as a potential concern, policymakers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation," said University of Oregon economics professor Tim Duy. "Such an outcome appears unlikely given persistently high unemployment."

In the meantime, the United States isn't the only country suffering from higher food costs. In fact, pressures here are tame compared to the rest of the world.

A Global Epidemic

World food prices hit a record high in December, jumping above the 2008 food crisis levels and developing into an "alarming" situation, according to a report released earlier this month by the United Nations' Food and Agriculture Organization (FAO).

The FAO's Food Price Index, which tracks the prices of 55 food commodities, climbed for the sixth consecutive month to hit 214.7 points in December, its highest reading since the measure was first calculated in 1990. This beat the previous June 2008 record of 213.5 and is a 25% increase from December 2009.

Soaring prices for sugar, corn, grain, meat and oilseeds pushed the index to its new peak. Sugar recently hit a 30-year high, U.S. corn prices surged 52% last year, European wheat prices doubled and U.S. soybean prices rose 30%.

Unfavorable environmental conditions, such as floods in Australia, contributed to the surge in prices. But observers have pointed out the prices were rising long before these events culminated in what's fast becoming a global crisis.

In parts of Australia, retail fruit prices jumped 17% between the September and December quarters last year and vegetable prices rose 15%.

Surging food prices in 2008 led to riots in more than 30 countries and this year have already touched off protests in Tunisia and Algeria.

European Central Bank President Jean-Claude Trichet earlier this week urged central bankers everywhere to ensure that higher food prices don't get a foothold in the global economy. Indeed, Trichet emphasized overall inflation, rather than the core measures favored by the U.S. central bank.

"In the U.S., the Fed considers that core inflation is a good predictor for future headline inflation," he said in an interview with the Wall Street Journal. But elsewhere around the world, "core inflation is not necessarily a good predictor."

A Bountiful Harvest for Agricultural Stocks

While rising food prices are a burden for most Americans, they're a boon for the U.S. agricultural industry.

U.S. farm income last year probably exceeded the 2004 record of $87.3 billion, and cropland values gained as much as 10%, Neil Harl, an agricultural economist at Iowa State University and former adviser to the governments of Ukraine and the Czech Republic, told the Pittsburgh Post-Gazette.

Higher prices will push U.S. agricultural exports up 16% to a record $126.5 billion this year, according to the Department of Agriculture.

The Department of Agriculture anticipates corn inventories will decline 5.5% this year to the lowest level in 15 years. Corn prices rose nearly 75% last year, catapulting shares of agribusiness companies and exchange-traded funds (ETFs).

The Teucrium Corn Fund (NYSE: CORN), which tracks the price fluctuations of corn, is up about 60% in the past year. And the Market Vectors Agribusiness ETF (NYSE: MOO), which offers broader exposure to the agricultural sector, is up 26%.

Companies that produce genetically engineered seeds that increase crop yields – like Monsanto Co. (NYSE: MON) and E.I. du Pont de Nemours & Co. (NYSE: DD) – also stand to gain.

Deere & Co. (NYSE: DE), the world's largest farm equipment manufacturer, has seen its shares surge more than 66% in the past year on higher commodities prices.

But if you really want to profit from the agricultural boom, you should pick up the Money Map Report's "2011 Investor's Forecast," which has already been delivered to subscribers. In it you'll find an industrial-equipment maker that's becoming the global leader of the worldwide agricultural boom and getting ready to blow past even Deere.  If you're not a Money Map subscriber you can sign up to receive the report by clicking here.

News and Related Story Links:

• Bureau of Labor Statistics:
  Consumer Price Index Summary
• Money Morning:
  Energy Forecast: Oil Prices Poised to Again Test Record Levels in 2011
• The Tennessean:
  Consumers hit with higher food prices
• Money Morning:
  
  Record High World Food Prices Spark Fears of Looming Global Crisis
• Money Morning:
  United Nations Warns of Food Price Hikes, Painting a Picture Similar to 2008's "Silent Tsunami"
• Wall Street Journal:
  Global Price Fears Mount
• Pittsburgh Post-Gazette:
  Record food prices cause riots, stoke U.S. farm economy
• Money Morning:
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• Money Morning:
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• Money Morning:
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• Money Morning:
  Surging Corn Prices Making Hay for Commodities Producers
• Money Morning:
  The Only Investment "Forecast" You'll Need for 2011