Interest Rates Raise Currency Concerns

CME Economist: Currency Devaluations Could Make Ag Goods Less Competitive

Katie Micik Dehlinger
By  Katie Dehlinger , Farm Business Editor
As currencies in Argentina, Brazil and Russia weaken against the dollar, a CME Group economist warns the Federal Reserve's interest rate increases could spark currency crises in emerging markets, potentially affecting the price farmers receive on the global market. (Chart courtesy of Bloomberg Professional)

MOUNT JULIET, Tenn. (DTN) -- As the Federal Reserve slowly marches interest rates higher, the consequences for farmers could range beyond operating loans and farmland values: Currency fluctuations could affect the price U.S. agricultural goods receive on the global market.

Currencies are under pressure in Argentina, Brazil and Russia, and while the Ukrainian hryvnia has held its own, it remains vulnerable to a devaluation, Erik Norland, a senior economist at CME Group based in London, said in a paper titled "Should Farmers Fret About Falling Ag Currencies?"

"I think the short answer is they should be somewhat concerned about it," he told DTN in a phone interview. "And the reason is it just makes all of America's competitors, or farmers in all of these other countries, more competitive because it lowers their input costs."

He said there are certain costs that don't vary much from country to country, like the cost of fuel and farm equipment. The differences come in inputs priced in local currency, mainly labor costs and things like property taxes.

"As we see the selloff happening in the Argentine peso, the Brazilian real, the Russian ruble, that lowers the input costs for all of these other countries, which increases their farmers' profit margins; which can incentivize them to invest more in agriculture to increase their domestic production; which could mean more corn, soy, wheat products being produced in the future from those countries."

During bear markets, commodity prices often fall to the cost of production. Norland said it's the market's way of shaking out inefficient producers, reducing inventories and bringing the market back into equilibrium. While grain prices don't track with emerging market currencies on a day-to-day basis, comparatively weak currencies could lower the floor to which prices could fall.

"Farmers in places like Argentina, Brazil and Russia, where currencies are weakening, will be partially or mostly insulated from these negative effects," Norland's paper states. "Producers in places like the United States, whose currency is being lifted by the aggressive rate rises by the U.S. Federal Reserve, will not."

Currency markets have come to rely on cheap funding from the United States. The Federal Reserve put interest rates at 0% in 2008 to address the financial crisis and left them unchanged until 2015. It didn't pick up the pace of rate hikes until last year, when it raised rates three times. It's widely expected the Fed will hike rates again on June 13, at least one more time this year and two to three times in 2019.

"So as this easy financing goes away, one of the risks is we could have a more generalized emerging market crisis like we saw after Fed rate hikes in 1994, which led to a series of emerging market crises that began with Mexico and spread to Asia and then to Russia. And all of that was really, really bad for agricultural prices back in the 1990s."

Complicating matters, 65% of all global transactions are priced in U.S. dollars, he said. Only 25% are completed in euros while 10% are priced in all other currencies. For example, if a Turkish wheat buyer makes a deal with Russia, it won't be in rubles. It will be in dollars.

This creates a problem for currency traders, who often borrow money from the U.S. at low rates, lend it to countries like Brazil or Russia at a higher percentage, and pocket the difference.

"As the Federal Reserve raises rates, people are starting to cash out some of those trades, and that's starting to put downward pressure on these emerging market currencies," Norland said. "It's possible we could see a real blowup of these trades going forward, which could have really big consequences for commodity markets. If we see a sharp rally in the U.S. dollar that would normally be quite bearish for a variety of commodities, including agricultural goods and industrial metals, and maybe for energy as well."

He said hints of an emerging market currency crisis are already emerging in Turkey, where the lira has faced a sharp selloff in comparison to the U.S. dollar over the past week. While Tukey's not a competitor in agricultural exports, Norland said it's indicative of problems in a number of countries.

Norland said agricultural commodity markets are largely ignoring global currency risk, and the options markets indicate most market participants see more upside than downside risk to grain prices. Call options are pricey compared to puts, which he said could be a function of weather risk as well as low grain prices over the past five to 10 years.

"When we talk about the impact of currencies on grain prices, we quickly find that the conversation is very specific to each grain and that it is also difficult to discuss without bringing in several other factors for context," DTN Analyst Todd Hultman said.

"For example, for corn and soybeans, the significant competitors to U.S. export sales are Brazil and Argentina with Ukraine also supplying corn," Hultman said. "In 2018, drought in Argentina has significantly reduced its ability to export either corn or soybeans in the year ahead, an important limitation that makes its weaker currency a distant second in importance."

The Argentina peso has fallen 23% against the dollar so far this year, prompting its central bank to raise interest rates to 40% to combat capital flight.

In Brazil, Hultman said, the country's record 2018 soybean harvest and the ongoing trade dispute between the U.S. and China, which makes Brazil China's favorite source for imports, far outweigh concerns about currency.

The most vulnerable market is wheat.

"The most difficult roadblock for wheat prices is the plentiful global carryover of supplies that the new season is starting with," Hultman said. "Add to that an economic environment where competing currencies, such as the euro and the ruble, are falling while the U.S. economy is doing well and facing a path of gradually higher interest rates ahead, and bearish pressure on U.S. wheat prices seems likely again for the year ahead."

Norland said while currency and daily price movements in agriculture commodities aren't highly correlated, certain markets track together over time, like wheat and the Russian ruble or the Brazilian real and soybeans. He said the comparisons didn't matter as much during the 1990s currency crises because Argentina, Brazil, Russia and Ukraine weren't big exporters of agricultural goods at the time, but they are now.

"It just leads me to think that maybe the agricultural markets should be paying more attention to these emerging market currencies," Norland said.

You can find the full text of Norland's paper, along with charts comparing various currencies with commodity prices over time, here:…

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Katie Dehlinger