Markets crave stability and predictability. But the opposite occurred during 2015 in the U.S. cattle markets. In fact, last September’s shocking collapse in live cattle cash and futures prices (which I outlined in my October 26, 2015 column) capped a year when the futures’ volatility and irrationality caused huge financial damage to producers and packers.
The collapse eventually led a fringe producer group to demand a congressional investigation. Its demand caught the attention of several members of the U.S. Senate, who this April requested that the General Accounting Office (GAO) complete an assessment of the collapse. At time of writing, the Senate’s Agriculture Committee was planning to hold a hearing on the collapse.
The producer group, as it has done in the past, pointed its finger at packers. But it is clear that what occurred last fall was a massive sell-off in the futures that caused cash prices to tumble. That’s why industry groups asked the CME Group to take a close look at the behaviour of high-frequency computerized trading (HFT). The CME then pledged to make technical adjustments to trading rules in an attempt to reduce the volatility.
Most market participants breathed a sigh of relief in the first quarter when the futures market was relatively stable, albeit negative, in regards to cattle contracts. But the volatile behaviour abruptly returned the third week of April. The April and June live cattle contracts fell more than 500 points each in a few days and dragged cash prices down to their lowest level this year.
The April cattle contract ended up losing 837 points in 10 trading days while the June contract lost 725 points. All this was despite no change in market supply-and-demand fundamentals. In fact, the fundamentals are more positive than for at least two years. The sell-off immediately preceded the two best beef demand months of the year, so one might have expected the April and June futures to rally, not collapse.
The futures market proved just as contrary the second week of May. Cash prices rocketed higher as packers sought cattle for their largest slaughter week since June 2014. Cash prices increased $6 per cwt live from the week before and dressed prices increased nearly $10. But even as the trade was going on, the June futures contract closed 25 points lower than the previous day, at a $10-per-cwt discount to cash.
This action raised even more consternation about the futures’ behaviour and bewilderment to why they act so divorced from the fundamentals. The only reason market watchers could suggest for the April collapse was that HFT kicked in on technical stops and forced others out of the market. In the words of one trader, it was “the attack of the algorithms.”
Whatever the reasons, such irrational behaviour last year and again in late April caused significant psychological and financial damage to the cattle and wholesale beef markets. The sudden return of such behaviour has market participants wondering when it will strike again. Fears have been rekindled that the futures cannot be relied on as a price discovery mechanism or risk management tool.
The CME’s proposed measure had not been put into effect by mid-May. Market participants have little optimism it will have much effect anyway on HFT. As they point out, the CME is a for-profit business. It derives revenue primarily from trading fees. So why would it act to significantly reduce the amount of HFT and one of its most important revenue bases regarding live cattle futures? So participants are steeling themselves for yet more volatility.