I’ve received many inquiries from cow-calf producers regarding the outlook for the cattle herd over the next couple of years. Those of you who have read my articles in the past know that I advise Canadian cow-calf producers to expand when the U.S. cattle herd is contracting, and vice versa.
It was one year ago that North America went through one of the worst recessions in history. The common practice during a recession is to contract the herd because of low prices. However, history tells us otherwise. I thought this would be a good time to explain where we are in the cattle cycle and how cow-calf producers should respond. Canadian producers are price takers in a purely competitive market. Feeder cattle move actively both ways across the border until prices are equal. Therefore our focus is on the U.S. situation, given the size of its herd relative to Canadian cattle inventory.
A one per cent increase in consumer spending equals a one per cent increase in beef demanded. Consumer spending depends on consumer income. To be successful long term, the Canadian cow-calf producer has to focus on beef demand and disposable income of the average American consumer. The opportunity to make significant money is when the economy moves from the trough of the business cycle to the peak of the business cycle. There are four phases of the business or economic cycle that include: contraction, trough, expansion and peak.
When consumer incomes and spending increase, there is a direct relationship with beef demand. During contraction of the recession, consumer spending declines. When the economy is in the trough period of the recession, there is a sharp drop in interest rates. The U.S. Federal Reserve and the Bank of Canada post lower interest rates in an effort to enhance consumer spending. Once consumer spending starts to increase, beef demand also increases, pushing the cattle market to higher prices. I always tell cow-calf producers that the minute you hear that the Federal Reserve has dropped its benchmark lending rate to zero per cent from 0.25 per cent, hold back every possible heifer. This occurred in March of 2009 and again during March of 2020.
The U.S. cow-calf producer needs one year of prices above the five-year average before heifer retention starts and the cow slaughter declines. Then it takes 12 to 18 months of stronger prices before the calves of these heifers come on the market. In total, the timeline is 24 to 30 months of historically high prices before additional cattle numbers come on the market. The key point is that the U.S. cow-calf producer is generally still contracting or reducing the herd at a time when prices are making fresh historical highs. Throughout history, the U.S. cow-calf producer (generally speaking as herd mentality) bases their decision to expand or contract their cattle herd on the previous year’s prices.
What happened back in ’07
Let’s look at the example from the previous recession. The U.S. Federal Funds Rate was 5.0 per cent on August 2007; during May of 2008, the rate dropped to two per cent and by March 2009, the rate was 0.15 per cent. Rates stayed at these lows until December 2015 when rates moved up to 0.25 per cent.
The accompanying chart shows the U.S. calf crop (left axis) and the live cattle futures close at the end of July of each year (right axis). The live cattle futures made lows during the recession of 2009 — the July 2009 close was $84.70. Notice the calf crop was contracting from 2007 to 2014 but the live cattle futures were making fresh highs during 2012. It was 2015 before we realized the first year-over-year increase in the calf crop. Ironically, this was exactly the same time that interest rates were starting to increase.
Without going into detail, the main U.S. herd expansion occurs when interest rates are at the highs or moving higher. I don’t show the data here, but the U.S. cattle herd went through a major expansion from 1980 to 1982 when interest rates were at the roof. The U.S. cow-calf producer tends to expand when beef demand is being curtailed due to higher interest rates. We’re going to see that again in 2023 and 2024. The massive price spike in 2013 and 2014 occurred because heifers were being held back, thereby reducing beef production beyond normal market conditions. The feeder market is unique because during the expansionary phase, the higher the price, the less is supplied to the market. Under normal conditions, the higher the price causes supplies to increase. The feeder market is a unique study for this reason.
In conclusion, interest rates have been at historical lows. The U.S. calf crop has been declining for the last two years and we’ll likely see one or two more years of lower calf numbers. Beef demand is increasing and we’re seeing significant strength in the deferred live cattle futures. My advice to Canadian producers is to expand the cow herd over the next two years. After this, the market will likely have topped out and we’ll see the results of the U.S. expansion with sharp year-over-year increases in the calf crop. The key is to be two years ahead of our U.S. counterparts.