The U.S. Federal Reserve cut its key benchmark rate by 25 basis points on October 30, bringing its lending rate to the range of 1.50 per cent to 1.75 per cent. This was the third rate cut since July and it appears that Federal Reserve Chairman Powell will wait for further economic data before making additional adjustments.
The U.S. Federal Reserve lowered its lending rate to the range of 0.0 per cent to 0.25 per cent during the recession of 2009. The first upward adjustment off the historical lows was in December 2015 which coincided with the historical high on the live cattle futures. The next upward adjustment was in late 2016. There were 25 basis point hikes in 2017 and four during 2018 bringing the rate to 2.5 per cent. The Federal Reserve had a neutral outlook for the first half of 2019 and then started the mid-cycle downward adjustment in July of this year.
Readers are probably asking what this has to do with the cattle market. Well, let me just say it has a fair amount of influence on fed cattle prices.
Back in December 2009, a cow-calf producer group from Western Canada asked me to provide a market outlook. At that time, calf prices were low and producers in this specific region were looking for ideas on how to lobby government or enhance their bottom line. There was even talk of a “supply management for calves.” Can you imagine?
I didn’t attend the conference but I wrote a paper basically stating that in one year it would all be behind them. Interest rates were at historical lows and would remain there for the first half of the decade. We all remember that fed cattle prices basically trended higher from January 2010 through December 2015. Emotional decisions are usually the wrong decisions in a competitive market environment.
If you study cattle feeding returns over the past 40 years, you will notice that the most profitable periods of cattle feeding occur during the expansionary phase of the business cycle. Consider a feedlot in Alberta that bought steers at 800 pounds every Wednesday for the last 40 years. The steers were fed a barley and silage ration and sold at a finishing weight of 1,250 to 1,300 pounds. This data could provide you with a monthly financial return for feeding steers. This monthly return could be compared to monthly financial returns of another asset such as owning Bank of Montreal stock, for example.
Before I proceed, readers need to be aware there are four phases of the business cycle. These four phases are expansion, peak, contraction and trough.
Analyzing the data, you would notice two main features amongst other points, which I won’t discuss here. First, the most profitable period of cattle feeding occurs when the U.S. economy moves from the trough of the economic recession into the expansionary phase of the business cycle. You would then notice the most consecutive profitable period of cattle feeding occurs during the expansionary phase of the business cycle. The U.S. Federal Reserve lowers interest rates in an effort to stimulate the economy during the trough of the recession. After the expansion is in full gear, the Federal Reserve usually increases interest rates to curb inflationary pressures, as we saw in 2015.
The U.S. Federal Reserve cut their benchmark rate by 25 basis points in July 2019, which was followed by two additional rate cuts. This was a mid-cyclical adjustment due to the slump in manufacturing and risk of trade-related uncertainty. August and the first half of September was a bearish period for the cattle market due to the fire at the Tyson plant in Kansas. However, the live cattle futures have been trending higher since making the seasonal lows. The futures market appears to be leading the cash market higher. There may be other factors coming into play as well which I won’t discuss or discount for the price move; however, the price behaviour of the cattle market is similar to past history.
There is another factor that feedlots need to consider. Lightweight calves — under 500 pounds — appear to be strengthening relative to other weight classes. Notice the October 2020 feeder cattle futures (see below) are trading at a $7 premium to the March 2020 contract. The U.S. calf crop for 2019 is expected to be 36.3 million head, down from the 2018 crop of 36.4 million head. The Canadian calf crop for 2019 is projected to come in at 4.2 million head, down from 4.3 million head last year. After four years of aggressive expansion, the calf crops are experiencing year-over-year contraction on both sides of the border.
In conclusion, we have a slight contraction in the calf crop and a bullish economic environment. We know from past history that this is usually a profitability period for the feedlot sector. Above is a chart of the April 2020 live cattle futures, which has experienced a $16 rally since the seasonal lows. The managed money funds have been a net buyer of nearly 70,000 live cattle futures contracts from September 17 through November 5. I’m not the only one who has completed the analysis mentioned in this article.