Sailing into the headwinds to achieve progress

Sailing into the Headwinds to Achieve ProgressMichael Swanson, Ph.D., Wells Fargo Chief Agricultural Economist

I’m expecting 2017 to be another year of rebalancing for agricultural exports. The fundamentals of food and agriculture remain strong with continuing population growth and improving food consumption in developing economies around the world. And, with global population growing at 1.1% annually, and global GDP growing at 2.5%, agricultural commodities have a strong base demand growth in 2017.                               

Agriculture and food production, as a whole, benefit from this strong base demand and growth, however the individual producers around the world need to examine their competitiveness to understand whether their share of exports and associated revenue will grow or shrink.

U.S. agricultural producers will overwhelm domestic demand growth simply through their efficiency gains between crop yields and improved livestock feed efficiency. U.S. population growth currently runs at about 0.7% annually which is great for the third largest country in the world in terms of population. At the same time, U.S. calories per capita have been flat for almost two decades. It is important to differentiate between calories and food spending. Food consumption has averaged about 2,500 calories per person per day. Food spending continues to grow in real terms as the U.S. consumer looks for quality, variety, and ease of preparation. Food companies benefit from growth of food and beverage spending, but agricultural producers don’t. They are stuck in the realm of commodity production, and they need to understand that competitive space.

U.S. agricultural producers need to access the growing global market to absorb their ever increasing productive capacity. They can’t stop the flow of yield-enhancing technologies being driven by genetics, material sciences, and data dynamics. So, they need to better adopt and adapt to them than their agricultural sector competitors. Hopefully, the yield-enhancing technologies are priced fairly between the supplier and the agricultural producer, but once available, it’s up to the producer to wring out the maximum advantage from purchased technologies, in order to be well positioned to compete in the global market over the long-term.

For 2017, the fly in the ointment is the interest rate and exchange rate dynamic. Interest rates and exchanges are not about the agricultural market, but they run in cycles that can make accessing the growing global demand both easy and difficult at the same time. The value of agricultural exports (bulk, intermediate, and consumer-oriented) peaked in 2014 at $150 billion. Through October of 2016, the same category has exports of $108 billion. With projected total agricultural exports of $128 billion for 2016, this represents a 15% decline. It’s important to put this into perspective with total 2016 farm gate revenues (livestock and crops) projected at $353 billion. The $22 billion decline in exports helps explain the softness in the U.S. agricultural space.

With the change in the market’s attitude about U.S. inflation and interest rate expectations, the U.S. Dollar has continued to strengthen. This will increase the disadvantage that U.S. exporters face relative to other sourcing options. One key example is the U.S. to Mexico relationship. In 2015, the U.S. exported $18 billion in agricultural products to our NAFTA partner, just behind Canada at $21 billion and China at $20 billion. Mexican importers source globally for the best price delivered to their facility in Mexican Pesos. So, while the U.S. has a key geographic advantage with the shortest and cheapest freight into many Mexican markets, that advantage has a limit. The following chart shows the big swings in the Mexican Peso to the U.S. Dollar and also to the Euro.

Mexican Peso Exchange Rates

Source: Banco de Mexico, Wells Fargo

Starting in 2014, the Mexican Peso has weakened against both the U.S. Dollar and the Euro, but it has weakened against the U.S. Dollar at a much faster rate. For much of this decade, the stronger Euro to Mexican Peso relationship ruled out European feeds and other commodities relative to the U.S. Dollar. The much stronger U.S. Dollar relative to the Mexican Peso and the Euro might not switch the sourcing of feed grains for most Mexican feeding operations, but it puts a cap on the ability for the U.S. to raise prices relative to alternative sources around the world. The relative exchanges matter to buyers as they ultimately sell to their domestic consumers in the local currency. This is just one example of the hundreds of cross exchange rate-reducing or capping scenarios that U.S. agricultural exports face around the world.

Euro To US Dollar in Mexican Pesos

Source: Banco de Mexico, Wells Fargo

It is just a fact of life that good news for the U.S. economy translates into a stronger U.S. Dollar as investors look to participate in that growth by buying U.S. Dollars to make both financial and physical investments in the U.S. economy. It also represents a real hurdle for the export-dependent U.S. agricultural producers. While it would be unwise to wish away stronger growth in the U.S. economy to avoid this negative growth factor, it leaves agricultural producers and processors weathering the stronger Dollar until it inevitably weakens based on some new development. So, 2017 will be another year of adjustment to the stronger U.S. Dollar and changing export opportunities.