The best budgets are updated and adjusted according to markets. Here, our economist, Matt Erickson, looks at the markets trends and costs shaping the 2023 production year.
Interest Rate Outlook
Material Prices: Impact on Producers
Diesel and Distillate Ending Stocks
Managing Cost of Fertilizer
Interest Rate Outlook
Summary Points
- The federal funds rate is now between 3% and 3.25% following September’s third consecutive 75-basis point increase. Markets project, with about 98% confidence, the Federal Reserve will approve a fourth 75-basis points in November. This would place the Fed’s benchmark rate between 3.75% and 4%.
- The market also projects the level of rate increases will slow after December, peaking in the first quarter of 2023 in the range of 4.75% and 5%. This would put the average prime loan rate between 7.75% and 8% based on the historical 30-year spread between the average prime loan rate and the federal funds effective rate.
Why This Matters
The hotter-than-expected September consumer price index (CPI) report contributed to the market’s prediction that we will see a fourth consecutive 75-basis point rate increase in November. The CPI rose 0.4% in September after rising only 0.1% in August. On a year-over-year basis, the September CPI is 8.2%, keeping it at levels last seen in the early 1980s. More concerning was core CPI (excluding food and fuel). It rose 6.6%, the highest since August of 1982. This wide-ranging category includes services such as medical, pet and personal care, transportation services, etc. Wages are a major cost for service providers. The increase in core CPI could be an indication that wage increases are showing up in higher prices to consumers.
The Federal Reserve also continues to watch employment. The tight labor market and resulting wage pressure continues to fuel inflation. The ratio of unemployed persons to job openings has been less than one-to-one since May 2021. August job opening data signaled for the first time that the Fed’s interest rate hikes may be taking affect. The number of job openings declined about 1.2 million between July and August. This is the highest decline in nearly 2 ½ years. However, the market remains tight. In August, there were 1.7 job openings for every unemployed person. Layoffs also remain low. These factors will keep the Federal Reserve on its hawkish path of tightening its monetary policy.
In an environment of tightening monetary policy, uncertainty and volatility, planning for 2023 costs can be difficult. Continue to focus on and plan for what is known, using market data as a starting point. For example, it is clear the Federal Reserve wants to maximize predictability to minimize market disruptions, and interest rates likely will remain the Fed’s primary tool to effect policy. Another known: The prime rate tracks closely with the federal funds rate. The chart on the right shows that in the past 30 years, the spread between the average prime rate and the federal funds rate is 306 basis points. By February 2023, if market probabilities hold from the CME FedWatch Tool (as of October 25, 2022), the likeliest outcome would place the average prime rate between 7.75% and about 8%.
As you prepare your 2023 budget, the CME FedWatch Tool can help inform the direction of the federal funds rate. From that point, incorporate the historical spread between the federal funds rate and the prime rate and tailor it to your operation. Your Farm Credit financial advisor can help you stay current on the interest rate environment.
Material Prices: Impact on Producers
Summary Points
- On a seasonally adjusted basis, the producer price index (PPI) increased 0.4% in September, which was higher than the 0.2% anticipated before the report. On a 12-month, non-seasonally adjusted basis, the PPI rose 8.5%, slightly lower than 8.7% in August.
- From August to September, the PPI for softwood lumber fell for the second consecutive month to 2.9%. Since their March 2022 peak, softwood lumber prices have fallen 39.5%.
- The PPI for ready-mix concrete, by comparison, rose 1.4% in September, the six consecutive monthly increase. The PPI for ready-made concrete is up 8.9% so far this year and 11.6% year-over-year.
Why This Matters
A rising PPI often is a precursor to consumer inflation because businesses generally pass on their costs to consumers. Conversely, easing of the PPI can indicate consumer prices will ease. The PPI decreased, on a seasonally adjusted basis, the prior two months only to pick back up. Higher food prices and home heating costs helped drive 0.4 % increase in September. Meanwhile, U.S. prices of building materials decreased by 0.3 %.
For agriculture and especially those looking to expand their operations, the past year’s soaring prices for materials such as lumber and concrete, has been challenging, in no small part because they also are paying more for inputs and labor. While prices for overall building materials decreased 0.3% in September, the prices for many materials, including concrete and lumber, have a way to drop to return to pre-pandemic levels.
At its March peak, lumber cost more than $1,460 per thousand board feet before falling 63% to $535 as of October 20, 2022; this still is well above pre-pandemic levels. The PPI for soft-wood lumber (chart on left) has declined 40% since March but remains about 40% above pre-pandemic levels. The high cost of lumbers, combined with increasing interest rates, has slowed permits for new residential construction; permits are down about 17% since March and 3% when comparing September to the same period in 2021.
As the chart on the right shows, ready-mix concrete has increased 8.9% year-to-date, the largest increase on record dating back to 1990. The acceleration of construction activity and higher infrastructure spending are two reasons affecting the price of concrete, cement, and other aggregate products.
Diesel and Distillate Ending Stocks
Summary Points
- As of October 7, 2022, weekly U.S. ending stocks of distillate fuel oil were at their the lowest seasonal level since the Energy Information Administration (EIA) began collecting data in 1982. Week-over-week ending stocks, as of October 14, increased 0.1%, more than 20% below the 10-year average.
- The shortage of distillate fuel oil is putting upward pressure on diesel fuel prices. At the retail level, diesel fuel sold for more than $5 per gallon during the second and third quarters of 2022, well above the 10-year average of $3.26 per gallon.
- EIA projects diesel fuel prices to decrease from an average of $4.97 per gallon in 2022 to $4.29 next year.
Why This Matters
Seasonal factors generally play a role in distillate fuel inventories, with a build up in the warm summer months, followed by declines in the fall as Midwest producers harvest and in the winter heating demand increases in the Northeast. The seasonal timing of this year’s decline is alarming. Here is a look at the factors shaping this market:
- War disruptions. Before its invasion of Ukraine, Russia exported distillate fuel to the U.S. – 8.8 million barrels in 2021. U.S. sanctions on Russian petroleum exports cut off the supply and created a shortfall in the U.S. market.
- Robust exports. Russia also has been a leading distillate supplier to Europe, where Russian crude and oil products will be banned in the next few months. The U.S. has stepped in as a critical supplier to fill global shortfalls going into winter.The 4-week average ending October 7, 2022, indicates the U.S. exported 1.5 million barrels a day of distillate, up from an average of 1.17 million barrels per day between 2017 and 2021.
- Demand for diesel. Post pandemic, demand for diesel has recovered relatively quickly. From June 1, 2020, to October 7, 2022, the four-week average disappearance of distillate fuel oil has increased 32%. All these factors are putting a strain on supply and putting upward pressure on diesel fuel prices.
Looking ahead to 2023, the chart on the left shows projections of low ending stocks continuing for the rest of 2022 (red dots) and 2023 (yellow dots). For the entire month of October 2022, projections put monthly distillate ending stocks 28% below the 5-year average. The 2023 projection is 24% below the 5-year average.
These levels of ending stocks will keep upward pressure on wholesale and retail diesel prices into 2023. However, with tighter macroeconomic conditions and growth here and abroad heading into next year, EIA projects declining (annual) diesel fuel prices in 2023. Regardless, retail diesel prices are projected to stay well above their 10-year average.
Managing Cost of Fertilizer
Summary Points
- National average prices for anhydrous ammonia increased 4.5% to $1,419 in recent weeks, after trending lower for 14 consecutive weeks between mid-May and late August. The national average price for MAP and potash, by comparison, has declined more than 2% and 1.7% respectively. Each fertilizer remains at record high prices for this time of year.
- The three charts above stack 2022 prices (red line) and 2021 prices (dark blue line) with each fertilizer’s 5-year and 10-year average. When compared to this time last year, prices for anhydrous, MAP and potash are higher by 51%, 14% and 21%, respectively.
Why This Matters
High input costs are expected to be a challenge for producers in 2023. Consider the average cost for the month of October, assuming an application of 200 pounds each of nitrogen and potash and 100 pounds of MAP. Compared to its 10-year average, anhydrous costs are up 131% ($171 per acre vs. $74); potash, 93% ($87 vs. $45) and MAP, 79% ($50 vs. $28).
With the exception of 2021 and its unprecedented disruptions to the supply chain, fertilizer historically costs less in the summer leading up to harvest and increases as producers start applying their fall applications and begin locking in their crop rotations for a new planting season.
If fertilizer prices haven’t been locked in for 2023 needs, continue to monitor market prices and insert them into your preliminary budgets for 2023. Remember, budgets are expected to change as markets change. By tracking costs and updating budget assumptions, you are better positioned to identify the right mix of cost and revenue for your operation.
The columns in the charts above show an example of the average October price for anhydrous, MAP, and potash on a cost per-acre basis, using the same applications listed above. These estimates can be used as a starting point, but tailor them to your operation. As markets change daily, weekly, etc., keep plugging updated numbers into your 2023 budgets until prices are locked in.
The best way to manage volatility is to monitor the market and its trends – and plan. As the fall and winter season approaches, market volatility and uncertainty are unlikely to go away. This is particularly true in the fertilizer and natural gas markets.
