Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Grains Update: Wheat remains in the driver's seat
Ole Hansen
Head of Commodity Strategy
Global wheat prices continue higher today in response to ongoing challenging growing conditions in Europe, the former Soviet Union (CIS), and Australia, which is experiencing one of its driest winters in history. Significant downgrades in both the quantity and quality of the current crop in the European Union and CIS were highlighted by the International Grains Council last week as the reason for cutting the outlook for world wheat production in 2018-19 to 721 million tons, a five-year low.
The biggest year-on-year percentage change was seen in Russia where this year’s crop is forecasted to fall below 66 million tons (from a previous projection of 70.9 million and far below the 84.9 million tons recorded last season).
Adding to the market unease is a potential change in the outlook for wheat production in the US. Recent expectations by the US Department of Agriculture for a record spring wheat yield have been somewhat dented. This comes after the annual Wheat Quality Council tour in the Northern Plains unexpectedly found below-average yield potential caused by hot weather earlier in the season.
The combination of lower supply and increased demand is likely to support wheat as well as corn prices over the coming weeks, or at least until the actual harvest results begin to tick in from the different regions. The lack of rain across Europe has turned normal green grazing fields into something resembling sandy beaches. As a result, farmers have been forced to dig into their winter feed stocks in order to keep their livestock alive and this development is currently driving demand and wheat prices higher with buyers looking to cover/hedge their winter requirements.
Following a significant rally this month Chicago soft red winter wheat (ZWZ8) and Paris Milling wheat (in dollars) are currently both higher by around 16% year-to-date.
No major upward revisions to production (with the possible exception of Canada) are expected with harvests either well under way or about to begin. On that basis, the main downside risk to wheat prices could once again emerge from the speculative long becoming too crowded. In the week to July 24 – before last week’s limit up spike in ZWU8 – hedge funds bought 20,385 lots, the biggest weekly jump in five months, to a one-year high of 23,942 lots.
Buying is likely to have continued during the recent days putting the CBOT net long on track to reach 45,000 lots. This level of positioning has on several occasions since 2013 led to profit-taking and weaker price action (as per the chart below).
El Nino risk on the rise
Adding insult to injury, Bloomberg is reporting that the US Climate Prediction Center has put the chances of an El Nino even between December and February at 70%, with the article stating that “the pattern, driven by a warming of the equatorial Pacific Ocean, can profoundly impact the planet, baking swathes of Asia, making it wetter in California and risking drought in Brazil”.
On July 31, Australia’s Bureau of Meteorology will provide its next update on the El Nino event outlook.
CBOT wheat (futures: ZW or CFD: WHEATmmmyyyy) is the global benchmark due to its strong liquidity and price discovery across multiple months. The most liquid contract is currently September, followed by December. An area of resistance between $5.50 and $5.75/bu has emerged on the first month continuation chart while support looks firm below $5.25/bu, last week’s correction low.
There are currently a very limited number of ETFs offering pure exposure to individual grain products. One of them is ETFS wheat which is designed to track the Bloomberg Wheat Subindex Total Return (ticker: WEAT:xlon)
A continued rally in wheat is likely to attract demand for demand for corn on a substitution basis. This is particularly likely given that Dec-18 wheat is already trading at the highest premium to corn in more than three years.
September corn (ZCU8) is once again testing resistance at $3.66/bu, the 38.2% retracement of the May to July sell-off. A break above is likely to attract interest towards $3.75/bu based at least partly on the fact that funds held a net-short of 130,000 lots in the week to July 24. This compares with a three-year average short of 36,000 lots.
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