The COVID-19 pandemic and the resulting government mandated stay-at-home restrictions and social distancing policies have wreaked havoc on global economic and financial markets. The swift pace of demand destruction and historic levels of job losses pushed both the U.S. and global economies into a likely recession over the course of just a few weeks. However, overall economic activity appears to have bottomed in April as the majority of governments have begun phased reopening's and tepid optimist for a recovery has returned to the majority of market participants.
After spiking to 14.7% in April, the U.S. unemployment rate declined to 13.3% in May as 2.8 million jobs were brought back online during the month. Employment in food services rose by 1.4 million during May, accounting for about half of the total jobs added during the month. For reference, May’s gain in food service jobs follows a combined loss of 6.1 million such jobs in March and April. Michigan has been hit particularly hard from a labor perspective, with the State’s unemployment rate equaling 21.2% in May, well above the national average. Wisconsin has fared slightly better than Michigan with an unemployment rate in May of 12.0%, slightly below the national average. While the May employment figures do provide some cause for optimism given that the labor market appears to have troughed in April, both the unemployment and labor force participation rates remain at multi-decade highs. There is still some disagreement among economists as to how fast the labor market will tighten now that many coronavirus-related restrictions are being eased, however early indications are that while overall economic demand has improved dramatically in the last month it remains well below pre-coronavirus levels. Many consumers are indicating that they are still not comfortable engaging in activities such as eating at restaurants or patronizing movie theaters even in states that have already fully reopened, which creates some uncertainty around when the economy might fully recover.
While some service sector establishments can reopen while limiting capacity to 50% in an effort to keep patrons a safe distance apart, these restrictions will further compress margins in an industry that already operates at relatively tight margins. Overall, while there is some cause for optimism in the May jobs data, risk remains that many businesses, particularly small business with a consumer-oriented business model, may not see demand rebound to levels that support profitability for some time.
One bright spot in the recent economic data is the housing market, which has remained surprisingly strong despite all of the coronavirus-related uncertainty. Existing home prices continue to exhibit relatively strong growth (continuing a trend that has been underway for several years) in light of record low mortgage rates, relatively low levels of single-family housing inventory, and a shift from urban living to suburban living by many millennials that are now beginning to form households and purchase homes. The increase in home ownership among millennials is particularly interesting, as many within that demographic have been slower than their predecessor generations to purchase homes. COVID-19 appears to have only accelerated the already developing shift from urban to suburban living among millennials. After initially declining in March and April, housing starts have also rebounded significantly over the last month, again due to relatively low inventories of existing homes and low interest rates.
The coronavirus-related plant closures in the meat processing segment have drawn significant attention as many worry that back-ups at processing facilities will lead to a supply shortage for meat products. Pork and beef packers have been particularly affected, as JBS, Cargill and Tyson all experienced temporary shutdowns at some of their processing facilities in April/May following high numbers of reported incidences of COVID-19 among the workforce. At this point the situation appears to be stabilizing, with many plants reopening in late May after testing and properly quarantining affected employees. The reopening of these plants should have a generally positive effect on the producers within these protein sectors, as it alleviates some uncertainty around whether there will be sufficient slaughter capacity to handle all of the market-ready animals currently in production. For reference, during the first week of June slaughter rates for cattle and hogs were reported at 96% and 90% of year-ago levels, respectively. This represents a significant improvement, as slaughter capacity was briefly down by as much as 25%-30% during the peak of the crisis. Some risk still remains in the meat processing sector to be sure, particularly if new outbreaks of COVID-19 lead to more plant closures going forward, however the situation does appear to be improving at this point.
Most commodities were negatively impacted significantly by the coronavirus-related shutdowns of the economy, as evidenced by volatility in futures prices over the last several months. Grain, dairy, lumber and fuel (including ethanol) all saw significant price declines in late March/April due to demand uncertainty during the peak of the lockdowns. That being said, many of these commodities began to rebound off of their lows in May and June as the economy began to reopen and demand for commodity products returned. The dairy industry has been particularly volatile, with milk futures briefly falling to multi-decade lows in late April as a result of, among other things, supply chain disruptions and diminished demand from the K-12 school system. Milk futures began to rebound in May as a result of continued strong demand for fluid milk through the retail channel and are above pre-coronavirus levels as of the writing of this article. Other commodities have experienced similar, albeit less dramatic, rebounds in price over the last several weeks, which provides at least some optimism for many producers. That being said, significant commodity price volatility may continue in the short/medium term as future consumer demand trends continue to be unknown to some extent.
Trade continues to be a hot-button issue, particularly for agriculture. Recall that there was much optimism on the trade front earlier this year after the U.S. and China signed a new Phase I trade deal in January that promised to substantially increase U.S. agricultural shipments to China. Thus far in 2020 U.S. agriculture has seen mixed results on the export/trade front, with some commodities seeing record high shipments (pork) and other seeing records low shipments (soybeans). One winner has been the U.S. pork industry, which saw exports to China total 280,507 tonnes in the first three months of 2020. For reference, this level of pork exports represents a 300% increase compared to the same period in 2019. This dramatic increase in pork exports to China is directly related to the country’s 2018/2019 outbreak of African Swine Fever, which curbed Chinese pork production by at least a third, forcing reliance on pork imports to a greater extent than has historically been the case.
While record pork exports to China is certainly a positive development, it should be noted that 20,000 tonnes of U.S. pork shipments, roughly equivalent to one week’s worth of orders, were canceled in early June after the U.S. publicly rebuked China’s handling of protests in Hong Kong. Sources close to the situation have warned that Beijing recently ordered state-owned firms to “halt large-scale soybean and pork purchases” in retaliation over U.S. objections to China’s handling of the recent Hong Kong protests.
This re-escalation of trade tensions revives fear that the increased agricultural export targets laid out in the Phase I trade deal between the two countries may not come to fruition. It should be noted that the U.S. dollar has begun to weaken relative to most other currencies over the last month, which should provide some tailwinds for U.S. exports. As always, the export landscape, particularly as it relates to China, will remain a key factor for U.S. agricultural going forward.
Turning to row crops, 83% of Michigan corn was reported as planted as of the end of May. This represents a significant improvement compared to last year, when just 39% of corn was planted as of the end of May and is also above the 5-year average of 77% planted at the end of May. Likewise, 76% of Michigan soybeans were planted as of the end of May, which is above the five-year average of 62% by the end of May. Wisconsin’s planting progress has followed the same trend in 2020. At the end of May corn planting was 94% complete, compared to just 58% a year ago, and soybean planting was 88% complete, a significant improvement from the 34% planted at the same time last year. While wet weather caused some delays in late May, on average the corn and soybean crops appear to be progressing nicely in Michigan, Wisconsin, and across the nation. As of May 31st, 97% of respondents across the major corn producing states indicated that the corn crop was in “Fair”, “Good”, or “Excellent” condition. Further, 74% of respondents indicated that the corn crop condition was “Good” or “Excellent”. Similar trends hold true for soybeans, with 70% of respondents classifying the current crop conditions as “Good” or “Excellent”.
In summary, while forecasting economic activity and financial markets performance for the remainder of 2020 remains difficult, the picture is clearer than even just a month ago. The majority of financial and commodity markets appear to have begun a recovery from their lows reached earlier this year. Geo-political instability continues to provide uncertainty on the trade front, particularly to the Phase I deal with China which has significant implications for the broader economy and agriculture specifically. Ag producers and business leaders will need to remain agile as economic conditions are likely to remain fluid throughout the remainder of the year.
Report by Matthew Naeyaert, GreenStone Senior Credit Analyst, Capital Markets, and Nick Jablonski, GreenStone Credit Manager, Capital Markets
To view the article in the online 2020 Partners Magazine, click here.