Despite fears about escalating trade tensions, slowing global growth, and an inverted yield curve, the macro-economy has been surprisingly resilient during most of 2019. Outside of some relatively modest volatility, equity markets have performed well, with the S&P 500 up 19% year-to-date.
Trade tensions and their impact on global growth are expected to weigh on U.S. economic growth in coming quarters. Forecasted 2019 real GDP growth was recently revised down 0.1%, and now stands at 2.2%. Projected real GDP Growth for 2020 has been revised down by 0.5%, and now stands at 1.8%. That being said, unemployment remains low and consumer spending, which drives two thirds of the U.S. economy, is growing solidly. Additionally, core inflation is at a decade high.
On September 18, the Federal Reserve opted to cut its target interest rate range by an additional 0.25%, bringing it to the 1.75%-2.00% range. This represents the second 0.25% rate cut since late July. Although most major economic indicators have remained solid, inflation continues to run below the 2% target, which has spurred the Federal Reserve’s efforts to stimulate the economy. Federal Reserve Chairman Jerome Powell cites global uncertainty and its subsequent impact on business investment and export markets as among the primary suppressants to inflationary pressure.
It should be noted that there was some disagreement among federal officials over the September decision to cut rates. Three committee members voiced concerns that the economy isn’t in need of an extra boost from a rate cut and conversely, one official favored a deeper cut of 0.50%. Investors appear to have been hoping for a more severe rate cut, as evidenced by equity markets declining immediately following the announcement. Committee members are also split with regards to the appropriate course of action in the immediate future, with seven out of 17 officials projecting another rate cut in December.
Much of the uncertainty that is said to be hindering growth in recent months stems from escalating trade tensions, largely between China and the United States. Evidence of this uncertainty can be found in financial market volatility, which has increased due to, among other things, earnings concerns for multinational corporations with a heavy international presence. It is difficult to assess the progress being made behind closed doors with regard to trade talks between China and the United States; however, both sides recently took steps to ease tensions.
In mid-September, President Trump announced he would delay raising previously announced tariffs in an effort to not disrupt the 70th anniversary of the People’s Republic of China. In response, Chinese authorities announced they would consider resuming purchases of American agricultural products, while also naming a wide range of U.S. goods that will be exempt from tariffs enacted last year. Given these measures, markets have renewed optimism a trade deal will be reached.
While the general economy appears to be holding up reasonably well amidst the ongoing trade uncertainty, its adverse effects are becoming increasingly apparent in the agriculture, manufacturing and transportation sectors. Recent tariffs imposed on goods in these sectors pose a threat to consumer spending, which is likely to contribute to slowing economic growth.
Global economic growth has also maintained a positive, but slowing, rate. In addition to ongoing trade tensions between the U.S. and China, Brexit issues remain unsolved and monetary easing by several major central banks has yet to have much effect in terms of stabilizing and strengthening global economic activity. Global GDP growth estimates have been revised downward to 3.0% for 2019, 3.0% for 2020, and 3.2% for 2021. The United States and Europe are not the only contributors to slower global growth, however. Key emerging economies, such as China and India, have shown signs of slowing as well, as export growth has underperformed expectations.
Throughout much of 2019, the housing market has exhibited few signs of benefitting from the Fed’s monetary policy easing. However, recent data indicates housing demand may be on the upswing. Permits for future home construction have risen to levels not seen since 2007, and housing starts in August jumped 12.3% to a seasonally adjusted annual rate of 1.364 million units, representing year-over-year growth of 6.6%. Single-family homebuilding, which accounts for the largest share of the housing market, increased 4.4% to a rate of 919,000 units in August, the highest level since January of this year. Starts for the volatile multi-family housing segment soared 32.8% to a rate of 445,000 units in August, reversing the prior two months’ declines. Though rental inflation has slowed in recent months, this trend is not expected to continue as rental vacancy remains very low.
With regards to the agriculture sector in particular, on August 30 the USDA revised its forecast for 2019 total net farm income to $88.0 billion, a 4.8% increase over 2018 (2.9% if adjusted for inflation). If realized, in inflation-adjusted terms, 2019 projected net farm income of $88.0 billion would be 35.5 percent below the peak net farm income of $136.5 billion reported in 2013. It would also be below its 2000-2018 average of $90.1 billion. Much of the rise in forecasted net farm income for 2019 can be attributed to production expenses only rising 0.4% (a 1.3% decline on an inflation-adjusted basis).
More specifically, rising costs of feed and labor are expected to be offset by reduced spending on seed, pesticides, fuel/oil, and interest. Farm sector equity is also trending upward, with the USDA forecasting 1.8% growth, to $2.67 trillion, by the end of 2019. Much of this reflects a projected 1.9% rise in farm-sector real estate values during 2019. Total farm debt in nominal terms is forecast to increase by $13.7 billion (3.4%) in 2019, led by an expected 4.6% rise in real estate debt. The farm sector debt-to-asset ratio is expected to rise from 13.31% in 2018 to 13.49% in 2019. Working capital, which measures the amount of current assets available to cover current liabilities, is forecast to decline 18.7% from 2018.
Many local agricultural producers have faced uncertainty of their own, given the cold and wet conditions that lasted through much of the spring. As a result, days suitable for fieldwork throughout the planting season were limited and, given the widespread impact of the historically wet planting season, December corn futures rose sharply from the range of $3.65-3.75 per bushel up to as high as $4.73 per bushel in June. Much of this market reaction was due to the expectation that many farmers would plant soybeans instead of corn, driving planted acreage and the overall harvest lower for the year.
Throughout the summer, however, the USDA provided upward revisions for both planted corn acreage and yields, which indicated a larger harvest than was originally anticipated. According to the USDA, trade tensions with China (historically the largest purchaser of U.S. soybeans) may have influenced many farmers’ decision to plant corn instead of soybeans. As such, soybean production is now forecast to be down nearly 1.0 billion bushels, or 20%, from 2018. In total, the trade impasse with China, and subsequently lower soybean prices, led to 12.5 million fewer soybean acres being planted this year.
Michigan-based milk producers continue to face mailbox milk prices ($16.06/cwt) well below the national average ($17.39/cwt) due to a shortage of processing capacity in the state. That being said, the overall dairy market trend is favorable, as Michigan producers were receiving mailbox milk prices of $14.06/cwt in April 2018 and $15.72/cwt in April 2019. Milk prices have rebounded as several months of herd reduction driven by rising cull rates has put downward pressure on production levels.
As this rally continues, it is important to track the industry’s appetite for capacity expansion, which may drive prices lower once again. Based on the cost and availability of forage, as well as the anticipated scarcity of heifers in the coming months, it appears unlikely that we will see a meaningful herd expansion in the immediate future.
The fourth quarter will shed light on some of the uncertainties weigh on the agriculture sector, including crop yields and federal legislation around tariffs and other trade negotiations. How any positive market movement gained through these activities is offset by input costs will impact producers profitability in 2020.
To view the article in the online 2019 Fall Partners Magazine, click here.