Interest Rate Pause? Not Necessarily.

Tractor tilling a field

Our economist, Matt Erickson, looks at the current state of interest rates, diesel prices, grain stocks and more. Small economic shifts – and certainly bigger jolts, such as a recession – could easily upend producers’ expectations and plans for the year.

One More Interest Rate Hike - Are Market Projections Right?

Little Cushion in Distillate Market if Economic Activity Picks Up

Risk Management Decision Could be Pivotal For Grain Producers

Soybean Meal Supply and Price Outlook

Moisture, Summer Exports Will Shape Corn Market

One More Interest Rate Hike - Are Market Projections Right?

Summary Points

  • The March Consumer Price Index (CPI) rose 5% from a year ago, just slightly below pre-report estimates of 5.1%.
  • Core services, which have steadily increased since the fourth quarter of 2021 before leveling off some between February and March of this year, were up 4.1%.
  • Markets expect the Federal Reserve to increase interest rates by another 25 basis points at their May meeting. This would place their benchmark rate between 5% and 5.25%.
Figure 1. U.S. Consumer Price Index (CPI) Monthly for 2019 to March 2023
Figure 2. Market Yields for 2-year and 10-year treasuries Daily for January 1, 2022 to April 26, 2023

Why This Matters

Inflation persists despite nineteen, 25 basis-point increases over the past 13 months. Year-over-year inflation has declined since the peak from last summer, but it remains well above the Federal Reserve’s 2% target. As Figure 1 shows, the driver of inflation has shifted from energy last summer to core services such as shelter, airfare, and vehicle insurance.

Several significant data points were released in the past month, including:

  • The labor market remains tight with a March unemployment rate of 3.5%.
  • Jobless claims fell 16,000 to 230,000, keeping the four-week moving average low.
  • Job openings per unemployed person declined for a third straight month, but U.S. still has more than 1.6 job openings per one unemployed person. This has kept quit rates high, with employees in some industries maintaining the leverage to demand pay raises.

In the first quarter of 2023, employer spending on wages and benefits, as measured by the employment cost index, rose 1.2%. Markets were expecting an increase of 1%. From February to March, real personal incomes rose 0.2%.

Meanwhile, U.S. real GDP for the first quarter of 2023 came in slower than expected at an annualized growth rate of 1.1%. Markets had anticipated growth of 2%. Exports rose 4.8%, while gross private domestic investment fell 12.5%. Consumer spending was up 3.7% due to higher wages and the robust job market, but there are signs that households are pulling back. Saving rates are up. Borrowers increasingly are unable to repay car loans and debt on their credit cards. And the Expectations Index from the Conference Board – one measure of consumer confidence – remains at levels associated with a recession within the next year. It has been below 80 all but one month since February 2022.

Where should producers turn to gauge the direction of inflation and the overall market? As discussed last month, the bond market is a good place to start. Bond yields are a predictor of inflation because they cut into investment.

Earlier this year, as shown in Figure 2, yields on the two-year and 10-year treasury started to decline when the market thought inflation would resolve quickly. Then, February and March came, and a hotter-than-expected jobs report and a mixed inflation report sent yields climbing on expectations that inflation could create a bumpy economic ride. Shortly after, the collapse of Silicon Valley Bank occurred, sending yields in a downward spiral as investors fled to bonds as a haven from the high market volatility.

All signs point to the Federal Reserve increasing the benchmark rate at its May meeting by 25 basis points to a target range between 5% and 5.25%. If the 30-year average spread between the fed funds rate and prime holds, this would put prime between 8% and 8.25%, similar to levels seen back in 2007.

Markets expect the Fed to pivot after its May meeting and pause rate increases to assess the overall impact their monetary policies are having on the U.S. economy. In fact, markets are pricing in more than a 96% chance of at least a 25 basis-point reduction by the end of the year according to the CME FedWatch Tool (as of April 28).

With the Fed rapidly increasing interest rates during the past year and the labor market remaining stubbornly tight, it’s clear that a challenge exists. Markets might be projecting a peak in rates after the expected increase in May, but it’s also plausible that we will see additional rate hikes through the remainder of the year rate hikes this year.

Little Cushion in Distillate Market if Economic Activity Picks Up

Summary Points

  • Since last fall, U.S. diesel fuel prices have fallen due to slowing demand from manufacturing and freight activity. Diesel consumption in the first quarter of 2023 was down 12% compared to the same period last year.
  • Despite falling prices, U.S. ending stocks of distillate fuel remain exceptionally tight, similar to 2022 levels.
Figure 1: Weekly on-highway diesel fuel prices (stacked)
Figure 2: Weekly U.S. Ending Stocks of Distillate Fuel Oil
Figure 3. Weekly U.S. Product Supplied of Distillate Fuel Oil

Why This Matters

Despite exceptionally low ending stocks for distillate fuel, diesel fuel prices have been declining. Prices have dropped about 25% since last fall, while ending stocks are more than 15% below their seasonal 10-year average.

As shown in Figures 1 and 2, diesel prices typically climb in the spring as inventories drop on greater demand. This spring (the light red line), prices are bucking the seasonal trend. Here, we look at the forces driving current prices, factors that could again push prices up and what this means for agriculture.

U.S. diesel consumption has declined in recent months, as shown in Figure 3. It averaged 3.6 million barrels per day in December 2022, the lowest December average since 1998. Consumption also fell short of seasonal averages during the first quarter of 2023. It was down 12% from last year and 3% below the 10-year average.

Diesel demand is often a leading indicator of where the economy could be headed. Rising interest rates have impacted business and economic activity, and manufacturing and freight have slowed. This, in turn, has dampened consumption of diesel and other distillate fuel oils.

The shipments component of the Cass Freight Index, which measures overall freight volumes and expenditures in North America, fell more than 1% in March. Shipments for the month were about 4% lower year-over-year.

The ISM Purchasing Manager’s Index (PMI) shows contraction in U.S. manufacturing activity from November 2022 through March 2023. The PMI stood at 46.3 in March, the lowest since May 2020. As we enter the second quarter of 2023, April regional manufacturing data points to continued deterioration in business conditions. The following regional-level manufacturing data captured deterioration from March to April:

  • The Dallas Federal Reserve’s Manufacturing Index declined from -15.7 to -23.4.
  • The Federal Reserve Bank of Richmond’s composite manufacturing index fell to -10, from -5.
  • The Chicago Federal Reserve’s Manufacturing Activity Index fell from -7 to -55.

As it relates to diesel fuel prices, this is both good and bad for agriculture. Slower economic activity has helped lower producers’ diesel costs. Weekly average diesel prices are down 30% from their peak last June. As shown in Figure 1, the Energy Information Administration (EIA) projects falling diesel prices to continue through August. Prices are expected to remain below $4 per gallon through September.

But a deeper look at the supply and demand fundamentals should raise cautionary flags. Yes, diesel fuel prices are bucking seasonal trends, but ending stocks are well below their seasonal long-term average. Other than from last year’s levels, seasonal ending stocks are at their lowest level since 2008. And just six months ago (October 2022), distillate stocks were at their lowest since tracking began in 1982.

Demand is pulling back, and the U.S. economy has started showing signs of slowing despite a robust labor market. However, the distillate market has minimal cushion when it comes to ending stocks.

Producers should keep an eye on manufacturing and freight activity in the months ahead. Diesel prices likely will rise if manufacturing and freight activity shows signs of strengthening or, more likely, just exceeding expectations.

Risk Management Decision Could be Pivotal For Grain Producers

Summary Points

  • The world stocks-to-use ratio for corn remains tight. Meanwhile, the ratio for soybeans is near the 10-year average.
  • Smaller crops for marketing year 2022/23 are expected from several major corn-producing countries, including Ukraine and Argentina. Even if Brazil produces a record corn crop, as expected, it will take multiple marketing years for the world stocks-to-use ratio to increase relative to its 10-year average.
  • Markets will be heavily focused on the 2023 U.S. corn crop.
World stocks to use ratio for corn and soybeans for 2009/10 to 2022/23F
Brazil and Argentina corn production for 2010/11 to 2022/23

Why This Matters

The global stocks-to-use ratios for corn and soybeans tell different tales. Compared against its respective 10-year average, the world stocks-to-use ratio for corn is tight at 25.5%. Soybeans, by comparison, remain near their 10-year average at 26.9%.

Several of the world’s top corn-producing countries have or are expected to harvest smaller corn crops for marketing year 2022/23 due to war in Ukraine and weather challenges in the U.S., the European Union and Argentina.

War and a wet autumn season have reduced production in Ukraine, while the U.S., the European Union and Argentina have or are expected to see declines because of drought. In fact, Argentina is expected to see its smallest corn crop in five years. Brazil, by comparison, expects record harvests of both corn and soybeans. USDA has lowered Brazil’s corn production since the end of 2022, but only by one million metric tons, whereas Argentina’s corn production has been lowered by 18 million metric tons.

Real or Projected Corn Production Decline, 2021/22 to 2022/23

U.S., -8.9%
European Union, -25.8%
Argentina, -25.3%
Ukraine, -35.9%

Overall, global corn production is expected to decline about 6% in 2022/23 compared to a smaller 3.9% drop in total demand. At this level, demand remains about 1% above the five-year average. Global ending stocks for corn are at the second lowest level dating to after marketing year 2013/14. History, of course, shows that tight supplies and the resulting increase in price incentivize production, leading to a correction.

Where does this leave U.S. producers and what should they watch for in 2023? Keep an eye on the impact of the ongoing war between Russia and Ukraine, as well as the seasonality trend in the corn market between June and August. This is when Brazil’s second corn crop – historically, about 70% of that country’s corn production – is harvested and hits markets and U.S. weather shapes fall yields.

The corn market could shift to a supply-driven rally with price risk on the downside if Brazil’s overall yield is higher than expected and U.S. corn acres and weather support trendline yields. A strong U.S. dollar would make it difficult to compete against record corn and soybean harvests in Brazil.

Risk management decisions this year could be pivotal.

Soybean Meal Supply and Price Outlook

Summary Points

  • Weekly soybean meal futures from March to April ended over 6% lower at $435 per ton.
  • Global ending stocks for soybean meal for marketing year 2022/23 are projected to drop to a nine-year low.
  • On average, for the past five years, Argentina has been the fourth largest producer and the largest exporter of soybean meal in the world. Drought conditions there are shaping current projections for global ending stocks.
Weekly Average Soybean Meal Futures
World soybean meal ending stocks for 2010/11 for 2022/23
Five-year average World soybean meal exports as a percent of world total

Why This Matters

Livestock producers continue to deal with high costs for feed, especially for corn and soybean meal. Although weekly soybean meal futures were down 6% in April compared to March, they remained over 17% above the 10-year average and in were line with 2022 prices.

Low global ending stocks are contributing to high soybean meal prices. USDA projects a 16.5% decline in ending stocks for 13.6 million metric tons for marketing year 2022/23. If realized, this would be the lowest level since marketing year 2013/14.

As one of the largest producers of soybean meal, Argentina has provided an average of 40% of the world’s soybean meal exports for the past five years. But severe drought is taking a toll on the country’s current soybean crop. Yields are expected to decline 17% compared to the last marketing year and the five-year average. Brazil, by comparison, is expected to produce a record crop and USDA projects it will help fill the gap with all-time high exports of soybean meal.

Five-, 10- and 25-year seasonal averages show soybean meal prices tend to be highest in the July-August timeframe and lowest in October and November. But seasonality patterns can be disrupted by any number of supply-and-demand factors. Currently, low supplies continue to support soybean meal prices. Looking ahead, China could be a factor. Demand from China is unclear, with news of a possible resurgence of African Swine Fever potentially impacting total hog output and, by extension, overall global feed demand.

Moisture, Summer Exports Will Shape Corn Market

Summary Points

  • Nebraska, Kansas and western Iowa have significant soil moisture deficits due to persistent dry weather. Kansas is forecast to experience continued drought at least through the end of July, while areas of Nebraska and western Iowa could see conditions improve.
  • Forecasts for much of the grain belt look favorable for corn and soybean planting. The exceptions: The Dakotas and Minnesota, where temperatures remain below average.
Figure 1 Monthly Temperature outlook for May 2023
Figure 2 Monthly Precipitation outlook for May 2023
Figure 3 and 4: U.S. Corn and Soybean Plantings Compared to Selected Planting Progress During High Prevent Plant Years after 2010

Why This Matters

It already has been a busy year for markets, with the risk of U.S. recession, boom and bust crops in South America, the Russian-Ukrainian war, a strong U.S. dollar and overall trade relations with China jockeying for attention from week to week. Now, with the start of planting season, the U.S. weather market officially begins for the 2023 corn and soybean crop.

The May outlook for temperatures and precipitation (Figures 1 and 2) generally looks positive for planting conditions. The Great Lakes states are projected to have below-normal rainfall, while the Dakotas and parts of Minnesota are expected to experience below-normal temperatures. Otherwise, there is an equal chance of above- or below-normal precipitation and temperatures.

The market appears confident farmers will get their crops planted. While it’s still relatively early in the planting season, the biggest risk of prevent plant is in the Dakotas and Minnesota, where winter refuses to recede. However, it won’t take long for producers to get a crop in the ground once the weather breaks.

Of course, wet conditions always are a major threat to planting progress. Many producers have vivid memories of 2019, the second wettest year after 1973. On average, producers have reported 6.4 million acres of prevent plant since 2010. In 2019, they reported 19.6 million acres. That year, corn planting didn’t surpass the halfway mark until the latter part of May. Soybeans lagged until mid-June.

By April 30 of this year, planting progress for both beans and corn was either at or above the five-year average. So far, so good.

However, soil moisture deficits in the western Corn Belt are concerning. About 30% of Iowa, including heavy corn and soybean production areas in the northwest portion of the state, was at least in moderate drought (D1 through D4). The good news is that the area of D1 through D4 drought in Iowa compared to three months ago has dropped considerably. Still, a couple of rains wouldn’t hurt. On the other hand, 77% of Nebraska remains in D2 and D4 drought, only a slight improvement from 84% three months ago.

In the top chart, Figure 5, the orange shaded regions show soil moisture conditions remaining below-average through May in much of the western Corn Belt. The bottom chart for the July outlook looks much the same.

Bottom line: the western corn belt will be more reliant on timely rains, much like last year, if conditions remain dry through the mid-summer months. Without rain, the U.S. could struggle to achieve trendline yields, and the market bulls will again have weather to point to as something to watch. At the same time, keep a watchful eye on U.S. corn exports throughout the summer. If purchases continue to fall, this will likely lead to higher carryover to the 2023/24 corn crop and potentially lead to a lower weather premium if conditions warrant over the summer.

Figure 5: Soil Moisture Outlook for May and July 2023
Figure 6: Seasonal Drought Outlook through July 31, 2023


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