Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Head of Fixed Income Strategy
Surging grain prices add to inflation unease
Ole Hansen
Head of Commodity Strategy
Summary: The six-month long bull market in crops received a fresh boost yesterday after the World Agriculture Supply and Demand (WASDE) report from the U.S. government lowered the outlook from already reduced expectations. The combination of cuts to U.S. corn and soybeans production and estimates for more exports helped support prices with both crops along with wheat surging to fresh seven year highs
The six-month long bull market in crops received a fresh boost yesterday after the World Agriculture Supply and Demand (WASDE) report from the U.S. government lowered the outlook from already reduced expectations. The combination of cuts to U.S. corn and soybeans production and estimates for more exports helped support prices with both crops along with wheat surging to fresh seven year highs.
The US Department of Agriculture (USDA) pegged the 2020/21 domestic soybean ending stocks outlook at 140 million bushels, down 77% from the 610 million bushels projected in August, and corn ending stocks at 1.552 billion bushels, lowest since 2013 and down more than 50% since the June projection. The USDA also lowered its forecast for upcoming harvests in key export countries Brazil and Argentina while highlighting the risk to supplies after countries such as Russia (wheat) and Argentina (corn) have or are considering to introduce measures to limit exports in order to preserve domestic supplies to keep a lid on prices.
The rally in agriculture commodities led by grains and oil seeds has to a certain extent occurred while the focus has been elsewhere. But the continued surge which has seen the Bloomberg Agriculture Index rise by close to 45% during the past six months has started to bring back worries about the impact on economies and inflation.
In recent updates we have been highlighting several supporting factors that are likely to see commodities continue higher in 2021. What is different this time, compared with previous and more short-lived rallies during the past decade, is that all three sectors of energy, metals and agriculture are all moving higher. Driven by a tighter supply outlook, a vaccine-led recovery in global demand and the prospect for a weaker dollar and increased demand for hedges to protect against rising inflation.
The 12-month roll-yield for holding a basket of 25 major commodities (ex. natural gas) has turned positive for the first time since 2014. Thereby supporting a continued inflow of funds betting that the sector will continue to thrive as inflows to value, cyclical and reflation investing strategies continue. As per the chart the big change in roll yields have so primarily been seen across the grains sector.
The catch-22 of these developments is the feedback loop of rising prices attracting an even higher amount of speculative buying, both from a momentum and reflation perspective. A development that is likely to create a period of elevated volatility as several commodities given the strong buildup in speculative positions, could be left exposed should the technical and/or fundamental outlook change. According to the weekly Commitments of Traders report, speculators entered 2021 with a record net-long position across agriculture commodities.
The total net long across 13 major agriculture commodities reached 1.2 million lots in the week to January 5, representing a nominal value of $41.5 billion. Biggest exposure was held across the soybean complex with 373k lots, followed by corn’s 350k lots and sugar at 229k lots.
There are several ETF’s that tracks the agriculture sector. An example being the WisdomTree Agriculture, a UCITS eligible ETC that is designed to track the Bloomberg Agriculture Subindex. After reaching a record low in June it has since rallied by 47% to a near three-year high.
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