Brazil and Argentina are Bailing Out the Fed on the Ag Front: Make Sure to Thank a Farmer

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Even before the planting season officially kicks off, U.S. farmers and ranchers are already facing an uphill battle on many fronts. Before glossing over this piece, since it's not as appealing as discussing A.I. or the unquantifiable tangible market for Nvidia (NVDA), it's important to note that the dynamics of the agricultural markets at this juncture have key economic impacts, including on inflation. So, buckle up, buttercup; we're hitting the countryside in today's note.

?Let's kick it off with the basics. The top U.S. agricultural products, in nominal dollars, are: Live Cattle, Corn, Soybeans, Lean Hogs, and, to a lesser extent, Wheat post the Ukraine/Russia conflict.

Live Cattle is obviously a staple within the U.S. diet when it comes to beef consumption, as it is one of the traditional sources of protein on a cultural basis. A smaller portion of this agricultural group is used for dairy production and breeding. Maintaining cattle production has become very difficult post-pandemic as input costs have risen exponentially, from feed to continued drought conditions. Ranchers have resorted to significantly reducing supply growth rates and focusing on weight to maximize margins. Drought conditions, as we will mention several times, are one of the major factors affecting every product.

The corn market has seen significant downside pressure since the highs of 2022 because of oversupply, but also due to increased competition from overseas competitors like Brazil and Argentina, who have expanded their corn production on a relatively exponential basis. Contrary to popular belief, most of the U.S. corn crop is consumed domestically, and it's not the delicious, sweet corn we enjoy at the dinner table. Most U.S. corn is used for livestock feed — although it is inferior to its protein-rich counterpart, soybeans — and for ethanol production. Foreign buyers have diversified their corn purchases to include Argentina and Brazil, moving away from the U.S.-produced crop, pushing prices down while planting costs continue to elevate, squeezing margins. This year, U.S. farmers are keeping an eye on production from Argentina and Brazil, as it is expected that their crop yields may further expand global inventories. However, weather stresses could dramatically change the pricing structure in the U.S.'s favor. In a sense, food inflation rests on these two South American powerhouses. Crop failure or lower-than-expected yields from these two producers will reignite the bullish thesis on corn prices.

The king crop around the globe, soybeans, faces similar headwinds as corn but with one caveat: China. Soybeans are considered by most within the ag space as the "miracle" crop because of their nutritional properties, durability in weather events, relatively low cost to grow, and their application as an all-around crop. Soybean is more nutritional than corn in relation to feedstock due to its protein properties and its ability to provide other essential nutrients like fiber and vitamins, and so rightfully, it goes for a premium compared to corn. Also, the applications for human consumption as soy products hold significant cultural standing and renewed interest across the globe. China has experienced some turbulence while ending COVID lockdowns, and as a result, the demand for Soybean & Soybean Meal has been lackluster until recently. Over the last 2 months, China has ramped up their soybean orders, which is a good start for the global markets, but once again, they're diversifying their purchases to expand outside of the main U.S. market and opting for producers in, as you may have guessed, Argentina and Brazil.

One of the main takeaways is the fact that South America has ramped up production of grains across the board, and this has now put pressure on U.S. agricultural products, squeezing margins for U.S. farmers and ranchers. That being said, weather events in South America have put some of these growth prospects at risk. Drought conditions in northern Brazil and excessive rains in certain parts of Argentina have stressed crop yields, but the market is unsure as to the extent. So, until we have a clear picture, grain prices continue to be depressed.

In the U.S., a different dynamic is taking shape right before the planting season. An abnormally warm winter has actually pushed up the prospects for an early planting season, which is naturally bearish for markets, but the caveat is the already excessive drought conditions within the corn belt, especially in Iowa and the southwest plains. This could result in crops being planted early and at risk of any reemergence of arctic behavior or excessive rains before the crops take root, washing away a considerable portion of the crop. The projected seasonal temperature and precipitation outlook by the National Weather Service may put additional stress on domestic crop and livestock producers who are already experiencing tight margins. For many, the only way to expand margins is to reduce supply in this environment, and we are early enough in the season where these adjustments could be made.

Nevertheless, if you ever get a chance, please thank a farmer and/or a rancher. With compressed margins, increased foreign competition, and the stress of the most unpredictable precious natural resource on earth, water, they have some tough decisions to make in the next 45 days: preserve margins or maximize production. The Fed is assuming producers will sacrifice margins countertrend to our European and South American counterparts. If you were in their shoes, what would you choose? Something to keep your eye on.