The F&A Sector after the US Election: What to Watch
After a long and turbulent presidential campaign, the American people have elected Donald Trump, the Republican candidate, as their 45th President. In addition, the Republican Party won the Senate, the House of Representatives and most of the down-ballot contested-for state offices in central US, which are heavily agriculturally-oriented. With one US Supreme Court vacancy and additional appointments likely to come in the next four years, Republicans now have nearly unprecedented control of the US federal government.
Trump’s policies are not clearly defined, but statements made during the campaign suggest they could be very different from current policies. The only certainty in the market at this point is uncertainty.
Although it is too early (and almost impossible) to quantify the implications of Trump’s policies, we believe these areas are the ones to watch from a strategic perspective:
- In the short run: agricultural markets may be affected by FX volatility as well as changing business appetite and consumer confidence.
- In the longer run: potential revisions to trade agreements, labour policies and business regulations, as well as effects on economic growth.
Initial uncertainty over policy direction caused a short-term sell-off reaction by markets. A lack of market information creates uncertainty, and uncertainty generates market volatility. Until we have more information about Trump’s actions as a President and his actual policies, the market will remain volatile, particularly when it comes to FX, rates and commodity prices, including agriculture.
The current volatility in the US dollar and currencies around the world are a direct result of this uncertainty. And clearly, this will have an impact on agriculture. Currently, the export share of US agricultural production represents more than 20 percent in volume and value terms, making US price formation highly dependent on foreign trade and therefore FX. The current FX volatility and trade implications, will impact US producers’ prices and margins, particularly those that are not hedged.
In addition, the current depreciation in currencies of emerging markets against the US dollar, such as the Mexican peso, may diminish imports from the US into those countries. Currently, Mexico imports around 18 percent of total US F&A exports. Mexico’s exports to the US may get a boost from the depreciation of their currency, and Brazil, a direct competitor to the US in global export markets, may become more attractive than the US, particularly in the grain & oilseed and animal protein exporting space.
The current uncertainty diminishes the appetite foreign businesses have to invest in US agribusiness. This may reduce the number of M&A transactions initially, although these transactions are likely to resume after policies become more defined. Finally, market uncertainty in the short term may lower consumer confidence in the US and globally, impacting some food consumption and trade trends.
Initially, we see trade agreements, agricultural policy and labour as key areas where there are potential policy-change implications for agriculture over the long term.
As the number one global agricultural exporter, the US F&A sector is one of the main drivers of global agriculture and trade. In 2016, US agricultural exports reached almost USD 127 billion, followed by Brazil and then China. Current US agricultural trade operates under a surplus of around USD 20 billion. The US exports different commodities that complement the rest of the world’s food supply. To illustrate, the US is the largest producer and exporter of corn, and US soybean exports make up 40 percent of global soybean exports (46 percent of US soybean production). Thus, any change to US agricultural trade agreements will not only affect global prices and trade dynamics but also US farmer margins.
While it is too early to know for sure, it is questionable whether US agricultural trade agreements, particularly NAFTA, will stop or go through major changes. This is because the US, Mexico and Canada are in many ways an integrated agricultural market. Currently, US agricultural exports to Mexico and Canada account for around 30 percent of total US agricultural exports. At the same time, agricultural exports from Mexico and Canada to the region account for 80 and 55 percent of total exports, respectively. For example, Mexican pork imported from the US represents around 12 percent of total US pork production. Mexican poultry imports also represent around 30 percent of total US poultry exports. Finally, the US exported 3.7 million tonnes of milk products (expressed as liquid milk equivalent) to Mexico in 2015—Mexico being by far the biggest export destination for the US.
While, these numbers represent significant trade values, they also illustrate the integrated nature of the North American animal protein supply chain. This also includes the beef complex, where Mexico and Canada are the suppliers to US feed lots and packing plants, which allows year-round processing. Mexican corn imports represent 23 percent of total US corn exports and are an important part of the animal-feeding supply chain. Many other sectors are integrated in similar ways. Consequently, changes to agreements such as NAFTA would have significant implications both for Mexican animal feeders, Mexican consumers and US farming profit margins.
Regarding other shifts in trade agreements and trade policy, the Trans-Pacific Partnership (TPP) is unlikely to happen during Trump’s administration. However, some markets, such as Russia, may reopen, and other markets may strengthen, like the United Kingdom. An improved relationship with Russia may see the end of the trade ban. Prior to the trade ban, Russia was the second biggest dairy importer and many of Russia’s imports originated from Europe. Yet, it could be that Europe does not benefit from an end to the ban, with Russia choosing instead to keep the sanctions in place. In this case, the US dairy sector may benefit, and that same logic may apply to US animal protein exports to Russia.
After Brexit, the UK is also in a position to look for stronger trade agreements, as evidenced by the enthusiasm already exhibited by the UK government.
Other changes in US agricultural trade policy will need to be analysed on a case-by-case basis to determine their domestic and global impact. Regardless, trade policy will continue to be a critical factor and a source of market uncertainty until it is better understood.
Farm Bill 2018
The current Farm Bill is scheduled to be renewed by 2018. As the Republican party has the majority in both houses, the development, approval and implementation of the 2018 Farm Bill is likely to be a smoother process than the two-year process of the previous Farm Bill. Some potential changes in the next Farm Bill include a revision of crop programmes to adjust to much tighter row crop margins. Due to the challenges US farmers are currently facing, the next congress and administration will need to begin setting policy objectives and direction as soon as possible. While the direction of the policy can be estimated, more concrete information will be necessary to alleviate market uncertainty.
Reduction in regulation has also been a clear policy direction advocated by Trump during his candidacy. While this may not materialise in the actual Farm Bill, it is likely that the direction of the Farm Bill will shift even more toward business sustainability and away from conservation. Increasing the budget for the Conservation Reserve Program is expected to become a key issue, along with an adjustment to the revenue support programs, including crop insurance.
The US food and agricultural policy is highly dependent on migrant labour, particularly in sectors such as produce, animal protein and food service operators. Assuming a stronger stance against illegal immigration, small business owners may face higher operating costs as a result of labour shortages, which would pressure their margins. In fact, US agricultural producers have already been facing rising labour costs, and lower labour availability, caused by increasing opportunities for labourers in Mexico, decreased birth rates in Mexico, and stricter immigrations laws.
The challenge for US producers is to remain labour-competitive. It is likely to see some changes regarding immigration and labour. Producers may need to start thinking more about technological investments.
The President-elect has discussed some fiscal stimuli to promote domestic growth by cutting taxes, particularly for more affluent earners, as a means of driving job creation. He has suggested increasing public expenditure, but we expect this to be limited in order to stay deficit-neutral. If this is correct, and assuming the US dollar and rates remain relatively stable, US economic growth should pick up, adding support to certain consumer food products, including premium products, such as organic food, premium wine and spirits.
Trump’s stated policy of reducing taxes for wealthy earners as a means of creating employment could create additional tailwinds for recent trends towards more premium and luxury food and beverages.
While premiumisation trends may see some tailwinds from expected fiscal stimuli, it is also worth noting that Trump appears to have won by mobilising a large group of disaffected voters who have faced financial struggles even as the top earners prospered (see Figure 1). It remains to be seen whether he can satisfy his constituency without adversely affecting the incomes of top earners. Any policies put in place to favour labour at the expense of capital could create tailwinds for some consumer staples but headwinds for premiumisation trends which could offset (to some degree) the tailwinds created by tax cuts.