For the agricultural futures and options markets, the uncertainty caused by current U.S. trade policies is creating both the best of times and the worst of times, according to a panel of experts speaking at the FIA's annual trade show..
Blu Putnam, chief economist at CME Group, noted that the overall level of trading in agricultural derivatives is generally up compared with last year. In particular, "short-dated options have just exploded," he said. These products are crucial for managing the risk of an immediate price break, he explained, when "some news comes out and prices move here to there very quickly."
The rise in trading reflects efforts by market participants to protect themselves from price volatility, but many U.S. farmers have stepped back from the futures and options markets or simply do not know how to use these products to manage their risks, according Al Kluis, a veteran futures broker based in Minnesota. His firm, Kluis Commodity Advisors, helps producers and processors with risk management needs through its offices in Minnesota, Wisconsin, South Dakota and California.
Speaking at the FIA Expo on Oct. 18 in Chicago, Kluis warned that the trade war has been "tough on farming" in general, and it could get even worse in the next few months as many farms have rent or land payments due in February and March. That has resulted in a brutal "survival of the fittest" among farmers, where those who don't understand how to hedge are increasingly being pushed out.
"We are seeing the well-educated farmers, the top 20 or 30%, that are profitable," Kluis said. "The less engaged farmers, they're going to have to either refinance or wind up working for the other farmers."
Much of the volatility in agriculture markets in 2017 and 2018 has been driven by trade policies, and in particular the escalating feud between the U.S. and China. The Trump administration has implement several rounds of tariffs on a wide range of Chinese imports starting in June. China has hit back by imposing tariffs on imports of soybeans and other agricultural products from the U.S.
China is an important export market for many agricultural producers in the U.S. and the harsh rhetoric emanating from the two sides has sent shock waves through the agricultural futures markets. The Bloomberg Agriculture Subindex, which tracks futures contracts on several commodities including corn, sugar, soybeans and wheat, has declined more than 25% since its early 2017 highs. Additionally, U.S. sales of soybeans to China have plummeted by 89% compared to a year ago, according to statistics published by the USDA in October.
Adding to the negative impact has been the effort by the Trump administration to re-negotiate the North American Free Trade Agreement. While that negotiation has reached a successful conclusion, along the way farmers were buffeted by threats of new tariffs on agricultural trade. In early June, for example, the Mexican government imposed a tariff of 25% on imports of cheese from the U.S., adding to the pressure on milk and cheese prices at CME.
The twists and turns of trade policy have taken a toll on farmers who have been too intimidated or confused to hedge, said Joe Barker, managing director at CHS Hedging, a commodity brokerage that provides risk management services to the agricultural and energy sectors. The trade war has caused period of "disengagement" where traditionally active participants "were just waiting" amid the uncertainty, he said.
Still, the panel was optimistic that the challenges caused by the trade war has resulted in a push for education on derivatives products and a reassessment of what products work best. Those factors are ultimately good for the long-term health of all agricultural market participants.
"Our markets are very resilient," said Barker of CHS. "I really believe in our markets, and I don't believe there's a better system than managing risk."
One example of how the hedging environment continue to evolve is the recently launched Dairy Revenue Protection program to help farmers protect against a decline in milk yields or prices. The program is sponsored by the U.S. Department of Agriculture and works much like traditional crop insurance.
Brian Rice, founder and owner of Rice Dairy, said customer demand for this form of insurance has been incredibly strong right out of the gate. Rice Dairy is a Chicago-based introducing broker that provides risk management solutions to roughly 800 clients in the dairy industry.
While it may displace some demand for agriculture futures or options, Rice said that long term it will help liquidity in derivatives markets by keeping clients engaged and educated in hedging tools.
Through the ups and downs of the trade war, "clients have learned a lot," Rice said. "One of the lessons has been that pushing away from the table was the wrong thing to do, and it's forcing people to get more educated about the other tools that are available."