As The US Drought Spreads To India, Will The Black Swan Be Deep Fried

Tyler Durden's picture

By now it should be more than clear that the entire hope-based, short-squeeze driven, algo-mediated rally is the result of the last traces of hope: with the US economy openly in free-fall mode, housing supported only by once again increasing shadow inventory (and even that myth is starting to falter following today's existing home sales update), corporate profits just barely holding in as a result of the last possible cuts into the bone via personnel terminations now that YoY revenue numbers have once again sloped lower and the corporate growth cycle has turned, there is little sustaining the market aside from the mysterious seller of endless vol, which could be well, anyone, and some quiet prayer that China may step in and once again, like back in 2009, be the marginal economic dynamo that restarts the global economy one more time. It would do that in the conventional way, of course: by easing as much as it possibly can. There is, however, one problem with this: food prices. As everyone knows the product the PBOC pays more attention to than anything else is food: pork, soy, corn, etc., and particularly food prices. Because if there is one thing that can cause social upheavals in the world's most populous country, it is a rerun of the spring of 2011 when as a result of global easing, we saw not only the Arab Spring, but violent flare ups throughout China. Which brings us to today's topic: black swans. Deep fried black swans.

As UBS explains the record drought that has gripped America may well have far-reaching implications beyond just the price of corn in the US. If, indeed, adverse US climatic conditions spread, and it appears they already have as "the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year" it means that Asian food prices will broadly be the next commodity sector to go sky high, and with that kill any hope of either an RRR cut, or an outright reduction in the PBOC's Interest Rate.

And with that the last leg behind the hope-rally will be gone, leaving only Simon Potter doing his magic until he finally sells enough VIX to bring it to single digits. And then what?

From UBS:

Asian food prices have generally trended down since late last year, but that could change. US agricultural prices are on course to increase a whopping 25%m/m in July due to a severe drought. That translates into about a 6%y/y gain. If US agricultural prices stop rising sequentially they should finish the year up 20%y/y. By itself that doesn’t justify panicking over Asian food inflation based on the traditional relationship with US agriculture (not yet anyway). Chart 1 shows the relationship is positive, but far from one-to-one. There have been times over the last decade when US agricultural prices and Asian food inflation have even decoupled. That could happen for example if weather conditions in Asia are favourable (particularly in India and China) or in other parts of the world that compensate for US agricultural output. However, our  fear is that poor weather on one side of the world tends to be followed by poor conditions on the other side.



If you’ve been following Philip Wyatt’s work on India then you know that the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year. That’s not a catastrophe, but it’s also not helpful given what’s happening in the US. The good news is that Chinese weather conditions have remained favourable for agriculture so far and that’s a positive. So this is where we stand. Recent US agricultural price increases are a negative for Asian food inflation, but not necessarily disastrous as long as local agricultural production can be sustained and that in turn depends mainly on the weather – something nobody seems very good at predicting.

Then again, praying for rain is oddly more appropriate and realistic than hoping that the central bankers will ease more with the US stock market at its 2012 highs.