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CoBank Quarterly: Clouds are forming -- Part 1

Executive Summary

Effects from the pandemic and the Ukraine war continue to reverberate through the global economy. Food and energy prices remain inflated, though prices for underlying commodities have lost upward momentum as economic fears increase. The Federal Reserve is poised to increase rates until it believes inflation has been tamed. Unfortunately the risk of over- or under-doing it is great given that the lag time between action and reaction in monetary policy can be long.

Supply chains are still a mess. Warehouse capacity is still difficult to come by and inventory is expensive. But transportation costs have decreased since Q1, offering a glimmer of hope of more-efficient days to come. Container shipping has become cheaper but conditions for agricultural transport are mixed. Rail, truck, barge and vessel costs remain stubbornly inflated and capacity limited.

While agricultural- and energy-commodity supplies remain tight, shifts in speculative sentiment have decreased prices from their peaks. For agriculture, replenishing grain and oilseed supplies globally will require two growing seasons. And there is no relief in sight for natural-gas supplies, ensuring power prices will remain inflated as well.

The remainder of 2022 will be far from ordinary and particularly difficult to forecast. The Fed’s job will become more difficult and its influence greater. But the U.S. economy and rural sectors in particular are best positioned to navigate what comes next.

Supply chains still broken

Dan Kowalski

Dan Kowalski

Dan Kowalski

Supply-chain improvements have been much more modest than the headlines suggest. And there is no fast lane ahead.

During the past quarter we have been reading headlines about the easing of supply-chain bottlenecks and overall improvements in U.S. logistics. But we are less impressed with the progress made to date. Commodity prices have declined meaningfully and lineups at California ports have shortened but supply chains are broadly still mired in dysfunction.

The Logistics Managers’ Index, as well as supply-chain indices managed by the New York Federal Reserve and Oxford Economics, indicate supply-chain performance has improved, both domestically and globally. But a closer look reveals that the improvement is the result of two developments.

  • fewer and faster export shipments from China due to COVID lockdowns there
  • relatedly, slightly reduced transportation-price inflation

The latest data show that warehouse and inventory costs are still increasing at near-peak levels, and transportation costs are still rising at a much greater rate than before the pandemic.

Agricultural supply chains reflect that marginal and inconsistent improvement as well. Grain rail-car availability and prices were at multi-year lows and highs, respectively, in the second quarter and have improved only recently in July. But those recent savings in rail rates have been partially offset by a dramatic increase in fuel surcharges. Grain export-vessel rates are also flirting with multi-year highs. And despite efforts to improve agriculture’s access to vessels returning to Asia from California, the share of vessels leaving port empty was still 70 percent in the first quarter – the latest available data. Truck rates have shown the most consistent decline, but are still at far more than pre-pandemic levels. Truck availability, however, is markedly improved.

We do expect that as consumer purchases of goods continues to soften, supply chains will slowly recover. If the oncoming recession in Europe is a harbinger of things to come in the United States, the decline in demand for goods will accelerate – further enabling supply chains to heal. But labor constraints will continue to hamper the recovery either way, making the return to an efficient supply chain agonizingly slow.

Economic outlook – Fed must slow inflation

Dan Kowalski

Dan Kowalski

Dan Kowalski

Despite financial-market all-consuming focus on inflation, the U.S. economy continues to advance. Labor markets are strong and consumers are still spending – although getting less for their money. Price inflation is still raging but a sag in commodity prices is increasing hopes that when transmitted through wholesalers and retailers, those reduced costs will be passed on to consumers in the form of smaller price increases. For now, though, the Federal Reserve has the data it needs to move forward with a 75-basis-point rate increase in July, and will be poised for another 50- or 75-point hike in September.

The Fed is now singularly focused on price stability and that’s increasing the risk to economic growth. The decrease in commodity prices along with recent bond-yield inversions are sending up red flags about slowing economic activity and a potential oncoming recession. And those concerns are validated by gross-domestic-product estimates. Current data show that gross-domestic-product growth was -1.5 percent in first-quarter 2022, and the Atlanta Fed’s second-quarter estimate is currently at about -1 percent. If the second quarter registers a negative number, claims that we are already in a recession will become louder. But many parts of the economy are still recovering well, and unemployment and underemployment statistics are back to pre-pandemic lows.

The relative outperformance of the U.S. economy and tightening monetary conditions have driven the value of the U.S. dollar to a 20-year high. That makes imports cheaper, which should aid in the inflation fight. But it hurts exports and U.S. businesses operating abroad. Benefits will flow to consumers but crimp several industries – and cause additional pain to developing economies.

As we predicted coming into 2022, it’s shaping up to be the year of the Fed. And the risks of a policy mistake are becoming larger with each Federal Open Market Committee meeting. Chair Jerome Powell is hyper-focused on preventing a hyper-inflation cycle similar to the one experienced in the 1970s to 1980s. Increased inflation became embedded during that period as a result of inconsistent monetary policy and an unwillingness to cause deep economic harm – that is until interest rates were finally increased to 20 percent.

The Fed has extensively studied the mistakes made in the 1970s and Powell has vowed to prevent such a long-term inflation problem. What he cannot so easily determine is just how much economic braking to apply without causing the economy to come to a screeching halt. Monetary policy is not a perfect science and the “softish” landing that the Fed desires will be a very difficult needle to thread.

Most economists are now projecting a better-than-even chance that the United States will be in recession by mid-2023. We echo those projections. Agriculture and energy are likely to continue performing well due to the Ukraine conflict but several other sectors will slow in coming months, just as the Fed intends.

Grains – Market volatility whips grain prices

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

As sentiment toward world-growth prospects has abruptly turned bearish, investors reduced their long position exposure to commodities as an asset class – which in turn has sent wheat and corn futures sharply downward during the past month. Looking forward, however, we see a floor on grain and oilseed prices. We expect prices will increase in the second half of the year given the especially tight global supplies of wheat and soybeans in particular amid steady demand for food, feed and fuel.

Commodity prices – Grain prices were again volatile in second-quarter 2022 as markets continually assessed, reassessed and reacted to the war in Ukraine, a smaller Brazilian soybean crop and ongoing dry conditions in the United States. Wheat prices – using the July 2022 futures contract as a benchmark – decreased a staggering 32 percent from their May peak level at almost $13 per bushel.

One could argue that the initial increase in wheat prices overshot the reduction in global supply availability but the opposite now appears to be the case on the selloff. In our view, global wheat markets will be supply-constrained for at least two crop seasons due to the war. And given consistent demand – mainly from food-insecure countries in the Middle East and North Africa – prices should experience upside pressure.

Planted acreage – Soybean planted acres decreased 2.9 percent, according to the U.S. Department of Agriculture’s June 30 Acreage Report, with the largest declines occurring in North Dakota and Minnesota. But because excessive rainfall in the Northern Great Plains delayed planting at the time of the survey, the USDA will re-survey both states as well as South Dakota in the coming weeks. Other notable domestic changes were a 0.5 percent increase in national corn acres and a 0.5 percent decrease in wheat acres.

Grain stocks – The USDA’s Quarterly Ending Stocks report showed modest changes to ending corn, soybean and wheat stocks. But that broad observation ignores a larger underlying story. Specifically, on-farm corn stocks increased by 22 percent year-over-year and soybean stocks increased by 17 percent year-over-year. That means farmers are holding onto old-crop bushels in anticipation of better prices in the future. That provides a key explanation as to why cash prices have spiked in certain locales where supplies appear available, but little grain is actually flowing. Corn basis levels in the Western Corn Belt are currently 50 cents to $1 per bushel better than five-year averages. That seems like a relative bargain compared to chronically grain-deficit California, where corn basis is well more than $2 per bushel.

La Niña and drought – The quarter saw alternative periods of modest rain, excessive rain and volatile temperatures, but the bottom line is that dry conditions are ongoing across many of the key grain-producing regions. Drought conditions have expanded in Illinois, Indiana, Kentucky, Tennessee, Missouri and Iowa. During the month of June, corn acres in drought increased nationally from 19 percent to 23 percent, and soybean acres in drought increased from 10 percent to 15 percent. An expected heat wave in early July could negatively impact crop yields, especially for corn during the critical July pollination period.

Crop Conditions – Challenging start better than 2021

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

Ag retailers powered through a somewhat challenging spring agronomy season, plagued by input-cost inflation, mixed weather and planting delays, and producer cost-cutting efforts. Crop progress recovered from delayed plantings with beneficial rains and warm temperatures. Corn, soybean and spring-wheat crops are outperforming progress compared to this time in 2021.

Fertilizer prices, which had gained 10 percent to 15 percent year to date through May – driven largely by fears of Russian-Black Sea supply and distribution disruptions, have pulled back recently in parallel with the normal lull in seasonal demand. But prices will likely remain at well more than long-term averages for a few reasons.

• underlying tight domestic fertilizer inventories

• strong demand from the United States, Europe, Brazil, China, India, and Canada – all major grain-producing countries looking to boost yields to satisfy local and export demand

• continued uncertainty related to the Russia-Ukraine conflict. Belarus is still under sanctions and Western buyers are hesitant about or have difficulty in navigating various financial sanctions with Russia

Farm-supply cooperatives and their grower members will face additional risks going into the fall agronomy season. First, Asian-made crop-protection chemicals continue to be in short supply due to supply-chain disruptions. Second, the Federal Reserve interest rate hikes mean that borrowing will be more costly.

Biofuels – Profits, production remain robust

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

Kenneth Scott Zuckerberg

The ethanol complex delivered a very strong second-quarter 2022 with few visible signs of demand destruction despite a spike in retail gasoline prices, worsening inflation, aggressive Federal Reserve interest-rate actions, a significant slowdown in the U.S. economy and deteriorating consumer sentiment.

Production averaged 15.5 billion gallons annualized, slightly less than the first quarter, which saw the industry build record stocks ahead of the summer driving season. Interestingly, consumer gasoline demand remains stable versus the previous summer and in line with the five-year average – despite national gasoline prices increasing to $4.88 per gallon compared to $3.10 per gallon a year ago. Average quarterly operating margins remained quite favorable at $0.33 per gallon, well more than the five-year average of $0.22 per gallon.

Ethanol exports hit a four-year best of 185 million gallons in April, increasing the four-month year-to-date growth by 67 percent. Increased sales were diversified among several key trading partners – namely Canada, Brazil, Singapore, Netherlands, United Kingdom and Peru. Export sales were less to South Korea and India, while China has thus far been absent. U.S. exports of dried distillers grains, an animal-feed co-product of ethanol production, decreased by 12 percent during the month of April. Year to date through April, exports of dried distillers grains have increased by 8 percent.

Dairy – production tightens, herd grows

Tanner Ehmke

Production – Milk collections in the United States remained tight this past quarter with record milk prices prompting only a minimal expansion in the U.S. dairy herd. U.S. milk production in May was 0.7 percent less year-over-year despite the cow herd increasing by 2,000 head from April. Totaling 9.4 million head, the U.S. milk-cow herd is still short 102,000 head versus a year ago. Record feed costs, extremely tight heifer inventories and inflated construction costs continue to limit expansion potential.

Feed costs eased at the end of the quarter but only incremental increases in cow numbers and milk collections are expected for the remainder of 2022. Expansions have thus far been limited to states like Texas and South Dakota in the central United States, where dairies typically grow their own crops and have more control regarding feed costs. Profitability has been strong for dairy operations that secured feed early or hedged feed prices early. New dairy-barn construction is underway in some regions, notably in areas where plant expansions have been announced.

Milk supplies remain constrained globally, with Europe and Oceania struggling with inclement weather, inflated feed prices and regulatory pressures to reduce greenhouse-gas emissions. Combined milk production in April in the European Union and the United Kingdom decreased 0.9 percent year-over-year. New Zealand production decreased a whopping 5.6 percent year-over-year. Ongoing cost and regulatory pressures are expected to limit milk-production growth for the remainder of 2022, tightening the world dairy-product balance sheet and sending more export business to the United States for cheese, whey, yogurt, nonfat-dry-milk and skim-milk powder, and other dairy products.

Processing – Milk continued to flow to cheese vats despite tight milk supplies this past quarter, with cheese manufacturers building inventories to record levels. Cheese production at the start of the quarter also continued its push to new records. But in a concerning sign of consumers responding to inflated food prices, American cheese disappearance decreased 10 percent year-over-year in April. Demand for other cheeses increased only 0.6 percent year-over-year. Retailers note consumers are also switching to cheaper-priced and private-label cheeses to save on cost.

The sharp slowdown in domestic-cheese demand coupled with increasing production pushed U.S. cheese inventories to new records, especially with American-style cheeses. Total cheese stocks were 1.5 billion, surging 31 million pounds from the previous month. U.S. butter inventories, though, continue to remain tight. Inflated prices and strong demand for U.S. milkfat from both domestic and international sources pulled butter out of storage.

Although U.S. cheese and butter exports have posted an impressive pace, inflation-wary consumers are trimming food budgets. That has raised concerns that ample cheese inventories could last through the remainder of 2022 and depress prices. Hopefully the strong export pace in recent weeks will continue, offsetting slower domestic offtake and providing a relief valve for bulging inventories, counterbalancing losses in domestic demand. With strict COVID lockdowns in China relaxing, expect a bounce back in demand there.

Central to the cheese-export story is Mexico, with the United States supplying 79 percent of Mexico’s total imports as of 2021. Mexican imports of U.S. cheese continually mark record numbers but concern is growing of reduced-to-middle-income consumers in Mexico paring back consumption in the face of increasing food costs.

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Dan Kowalski is an economist and vice-president of CoBank's Knowledge Exchange Division; he leads a team of economists to produce research for the agricultural and infrastructure industries that CoBank serves.

Kenneth Scott Zuckerberg is a lead analyst and senior economist in CoBank’s Knowledge Exchange division, where he focuses on grains, oilseeds, farm supply and biofuel. 

Brian Earnest is lead economist for animal protein in CoBank’s Knowledge Exchange division. He provides market and industry research for the poultry, pork and beef sectors.

Tanner Ehmke is lead economist for dairy and specialty crops in CoBank’s Knowledge Exchange research division, where his focus is on providing market and industry research for the dairy and specialty-crops sectors.

Teri Viswanath is a lead economist in CoBank’s Knowledge Exchange Division, where she focuses on the energy industry, including the electric distribution, generation and transmission sectors as well as the rural water industry.

Jeff Johnston is a lead communications economist in CoBank’s Knowledge Exchange research division, where he focuses on the communications industry. His work revolves around identifying emerging technologies, business models, risks and opportunities within the industry.

CoBank is a $158 billion cooperative bank serving vital industries across rural America. The bank provides loans, leases, export financing and other financial services to agribusinesses and rural power, water and communications providers in all 50 states. It’s a member of the Farm Credit System. Visit for more information.

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