Commodity markets have shifted in recent weeks. Our economist, Matt Erickson, looks at the factors shaping commodity prices, interest rates and more as we head into August.
Fed Interest Rate Hikes Changing Markets
- The 75-basis point increase announced by the Federal Reserve during its most recent meeting, July 27, raised the benchmark rate to a range of 2.25% to 2.5%, in line with market expectations going into the meeting. This was the fed’s second 75-basis point increase of 2022 and a direct response to the June Consumer Price Index (CPI), which reported inflation running at 9.1%, the highest level since 1981 and ahead of pre-report expectations of 8.8%.
- Markets anticipate the Federal Reserve will follow with a 50-basis point increase at its next meeting, which is in September.
- Markets are signaling the Federal Reserve could start cutting rates by next spring (2023). This contradicts the Federal Open Marketing Committee, which in June projected rate cuts wouldn’t begin until 2024.
Why This Matters
The Federal Funds Rate is at its highest level since December 2018. Last Thursday, the government reported U.S. GDP contracted for a second consecutive quarter, turning up the volume on recession alarms. And while the labor market remains strong with an unemployment rate of 3.6% and nonfarm payrolls of 372,000 (beating market expectations of 250,000), there are signs it is cooling; while initial claims remain low, the 4-week average has increased each week since the end of May.
At the same time, there are signs that inflation, while still high, could be easing. Crude oil prices are down 22% since the beginning of June; gasoline, 11%; wheat, 25%; lumber, 15%; and copper, 21%. Overall, the fundamental nature of the market is beginning to change under the Federal Reserve’s policy of monetary tightening. For the past two years, stock and grain markets were bullish. The bears have come out of hibernation the past couple months.
The increase in the cost of borrowing is impacting the entire U.S. economy. Consider the 30-year mortgage. In January 2021, homebuyers enjoyed a fixed, average rate of 2.65%. Today, interest on a 30-year mortgage averages 5.54%. A $500,000 home loan now costs $837 more per month than it did in early 2021 -- $2,851 vs. $2,014. The difference in interest costs over the life of the loan is $301,320. This is only $20,000 less than the median sales price of U.S. home ($322,000) pre-COVID. Rising interest rates, especially in combination with inflation, have reduced demand for mortgages; the purchasing price index is down 18% year-over-year.
Agriculture continues to benefit from strong commodity prices, but demand is down here as well as general economic prospects dampen. Uncertainty and volatility persist for producers and cost management is important for the 2022 crop and even more so, the 2023 crop. The good news is that prices are decreasing for fuel and, to some extent, fertilizer. Europe, however, does not have a quick solution to the natural gas crisis created by war tensions and reduced supplies from Russia. In the coming months and year, we will see some volatile price swings.
Be prepared and plan for your credit needs for the next year. Building a strong balance sheet will be important. And while you should look for efficiencies and ways to control costs, don’t make changes that are counter-productive and lower the quality of your output.
Factors Influencing Dollar
- The Federal Reserve has raised interest rates more aggressively than central banks in other major countries. This is the main reason the U.S. dollar, which reached parity with the Euro in July, has appreciated to a near 20-year high.
- Appreciation of the dollar makes U.S. products more expensive for foreign buyers and impacts industry sectors reliant exports.
Why This Matters
Global economic growth is down as individuals, businesses and governments struggle against rising costs. Many central banks are trying to tame inflation by increasing interest rates. None more aggressively or quicker than the Federal Reserve. Since the beginning of the year, the Federal Reserve has increased its benchmark rate from a target range of 0.0-0.25% to 2.25-2.5%. Since the beginning of the year, the U.S. Dollar Index has jumped nearly 13%.
Meanwhile, the European Central Bank recently raised its interest rate for the first time since 2011 -- by 0.5%. Russia’s decision to curb energy supplies to western Europe in retaliation for its support of Ukraine weighs heavily on EU growth. Higher interest rates could exacerbate Europe’s economic challenges, especially for high-debt countries like Italy. Meanwhile, Japan is dug in and unlikely to abandon a yield-control policy aimed at keeping interest rates down. As a result, the dollar likely will remain elevated compared to EU and Japanese currencies. Central banks in Canada, Brazil, South Korea and New Zealand, by comparison, appear more willing to increase rates. The outlook for the exchange rate market is best described as cloudy.
A stronger dollar is both good and bad. On the positive side, it makes imports to the U.S. cheaper, which could ease the cost of various goods for American consumers. Costs also could decline for global commodities priced in dollars, including crude oil, because purchasers using other currencies have to pay more and usually reduce demand to offset their higher cost. U.S. consumers would benefit if demand for crude oil dropped and led to lower prices at the gas pump. But a reduction in global demand for commodities such as corn, soybeans, pork and beef would negatively impact U.S. agriculture.
Two key factors will influence the dollar in coming weeks: Inflation in the U.S. and the willingness of other central banks to raise interest rates. The Federal Reserve likely will slow rate hikes if inflation softens. This would slow the pace of appreciation of or even weaken the dollar. If other central banks raise their rates, the magnitude of the increases will likely partially offset the strength of the dollar as it relates to a specific currency.
Markets Watching Weather, Producers Their Balance Sheet
- Crop conditions for U.S. corn and soybeans declined three and two percentage points, respectively, in the week ending July 24. The “good to excellent” rating applied to 61% of corn, lower than at any time over the past five years since July 2019, and 59% of beans, which only 2019 and 2021 had lower “good to excellent” conditions at this point in July.
- The dry conditions that persisted across much of the U.S. Corn Belt the past several weeks is expected to persist through mid-August.
Why This Matters
July precipitation was a story of the haves and have nots. Precipitation fell short in much of North Dakota, South Dakota, southern Minnesota, Iowa, Nebraska and Kansas, while much needed rain fell in parts of Wisconsin, northern Illinois, northern and southern Indiana and Ohio.
The forecast for dry and hot conditions persists for three to four weeks, well into critical periods for kernel and pod development. This poses downside production risk that could impact the corn and soybean balance sheets. Markets will be watching USDA reports on corn conditions and yield projections in August.
Shift in Corn Market
- Weekly average December 2022 corn futures fell 19% from mid-June to the latter half of July, eliminating the market premium seen from February through the beginning of June.
- Factors contributing to the decline in corn prices include recession fears, a hawkish Federal Reserve, June’s good weather and slightly higher-than-expected corn plantings in the June Acreage Report.
- Corn is in a weather market. July’s dry conditions in much of the Corn Belt and resulting deterioration in crop conditions are beginning to provide upward support for December 2022 futures.
Why This Matters
The corn market and other commodities experienced a general market shift from bullish to bearish in the latter part of the second quarter. Weekly average December 2022 corn futures peaked in May at $7.47 per bushel before falling to $5.87 in the third week in July. Crude oil fell 22% from June to mid-July; the DOW and S&P 500 are down 13% and 16%, respectively, since the beginning of the year; gold and copper, 16% and 31% since March; and lumber, 62% since March. Meanwhile, the U.S. dollar has appreciated to a 20-year high as a hawkish Federal Reserve tries to beat back inflation with interest rate increases.
Despite the changing landscape, corn is entrenched in a weather market. The western Corn Belt is hot and dry, and the weather outlook calls for more of the same in August. These factors are front and center in the market. December 2022 corn closed (as of Friday July 29) at $6.20 per bushel. Overall, as the 30-day percent precipitation map shows (see weather outlook above), there is a ton of variation across the Corn Belt that could eventually keep the U.S. corn crop in somewhat decent shape overall.
The July WASDE indicates supplies for corn remain relatively tight with a carry-out of 1.47 billion bushels, which, if realized, would be approximately 13% below the 10-year average. With corn usage projected to fall 2% in marketing year 2022/23 compared with 2021/22, the stocks-to-use ratio for 2022/23 increased to 10.1% from 9.6%. Historically, prices have been higher and more volatile when the corn stocks-to-use ratio falls below 10%. (See chart on U.S. Corn: Stocks to Use.) Historical trends suggest a farm price in the range of low $4 per bushel when the stocks-to-use ratio stands at 10.1%. This is well below USDA projected farm price of $6.65 per bushel.
However, this corn market is volatile and can change very quickly in the next month. The USDA farm price of $6.65 per bushel fits into marketing trends for 2011/12, when the stocks-to-use ratio was 7.9%, and 2012/13, when the ratio was 7.4%. Using the July WASDE corn balance sheet and historical relationships between the stocks-to-use ratio and average farm price, a stocks-to-use ratio of at least 7.7% would require corn growers to harvest an average of 173 bushels per acre, assuming all else constant. This is four bushels below the July yield projection. At the same time, USDA expects corn usage to decline 2% compared to 2021/22. If total usage was lowered an additional 1% from the July WASDE, holding all else constant, the result would be a stocks-to-use ratio of 11.1%.
The bottom line: Markets remain volatile with downside to production and demand. If downside occurs on both fronts, the magnitude of decline will significantly influence the corn market. The potential outcomes are wide-ranging, which adds to volatility and potential price swings.
Soybeans Impacted by Recessionary Pressure
- Domestic soybean stocks remain tight. USDA projects a 2022/23 domestic stocks-to-use ratio of 5.1%, well below the 10-year average of 8.1%. The global market also is expected to remain tight relative to use. For the past five years, the world stocks-to-use ratio averaged 28.3%. For marketing year 2022/23, USDA projects a world stocks-to-use ratio of 26.4%.
- The weekly average for November 2022 soybeans is down 14% since June, with global and domestic recession fears influencing the market. By historical standards, however, soybean futures remain robust.
Why This Matters
While the war in Eastern Europe has a more direct impact on commodities such as corn and wheat, the impact on soybeans has been indirect. Before the war, Russia and Ukraine exported approximately 75% of the global trade total in sunflower oil. With the substitutability of vegetable oils, the oilseed markets have reacted with the war in Eastern Europe. At the same time, a second consecutive year of drought in South America significantly impacted soybean crops in Brazil and Argentina, bringing bullish intent to the market. But, in June, recessionary pressures increased concerns about overall demand. As a result, commodity prices across the board fell sharply, and (weekly average) November 2022 soybean futures fell 14% percent, with much of the premium seen from the beginning of the year lost.
However, like corn, the soybean market is also in a weather market. Soybean futures continue to remain robust due to deteriorating crop conditions. November 2022 futures closed (as of July 29) at $14.68 per bushel, which are up from the week prior. The month of August is key for the U.S. soybean crop as pods set in and rain will be needed to help fill the pods.
Looking ahead, the global soybean situation is expected to remain tight. In fact, for marketing year 2022/23, USDA projects a world stocks-to-use ratio of 26.4 percent, roughly two percentage points below the five-year average. While it may take a couple of years for the global soybean situation to rebound, market conditions seen today will play a huge role in determining production amounts for next marketing year.
As is usually the case, high price environments often result in other countries bringing more acres into production and over producing. While it’s still extremely early, USDA projects a massive 2022/23 Brazilian soybean crop of 149 million metric tons. If realized, this would be 7% higher than Brazil’s historical high. The same thing occurred during high price environments in 2008 and 2012. Brazilian production increased 19% from 2008/09 to 2009/10 and 29% from 2011/12 to 2013/14. Depending on weather and fertilizer conditions, Brazil could again bring more acres of soybeans into production and overproduce. As demand softens due to past high price environments, supplies will go up and prices will go down.
A second consecutive year of drought in South America that significantly impacted Brazil’s and Argentina’s soybean crops and the war in Ukraine contributed to a bullish soybean market for much of the first half of 2022. But beginning in June, recessionary pressure led to concerns about demand, and soybeans, like other commodities, experienced price drops. November 2022 beans (weekly average) fell to $13.38 per bushel, down from $15.60 in June.
