Wednesday, December 7, 2022

What Is Behind The Recent Cotton Futures Market Plunge?

  • By Yangxuan Liu

The cotton futures market experienced its selloff since June 17, 2022, creating concerns among cotton producers about this year’s profitability.

For example, December 2022 Cotton Future prices dropped from around 120 cents per pound to around 96 cents per pound as this article was written on June 28, 2022. What was the cause of the recent market plunge?

Cotton and cotton-related products are discretionary items. Thus, cotton prices tend to follow the economy, with rising cotton prices during economic growth and declining cotton prices during recessions.

Many economic indicators point to the direction of economic slowdown, with the possibility of a recession in the United States. The S&P 500 index, one of the main indexes for the U.S. stock market, recorded a 20% drop in June from its January closing peak to confirm a bear market.

Meanwhile, soaring inflation put extra pressure on consumers. The annual inflation rate in the U.S. accelerated to 8.6% in May of 2022, the highest since December 1981. Among these, energy prices rose 34.6% with gasoline (48.7%), fuel oil (106.7%), electricity (12%) and natural gas (30.2%). Food costs surged 10.1% in the U.S., the first increase above 10% since 1981.

Severe supply disruptions caused by geopolitical tension and Covid-19 reduced global economic productivity, hindering the ability to meet consumer demand, resulting in an economic slowdown and high inflation rates globally.

Tracking Consumer Attitudes

The soaring inflation, especially for food and energy, reduced consumer confidence and forced the consumer to rebalance their budgets for spending. The University of Michigan Consumer Sentiment Index, tracking consumer attitudes and expectations about the future economic situation, was downwardly revised to a record low of 50.0 in June of 2022.

The U.S. retail sales unexpectedly declined by 0.3% in May. Under high inflation, with the prices of everything rising, the decline in retail sales implies that consumer reduced their spending on discretionary items. This could lead to consumers reducing the purchase of apparel and apparel-related products.

Meanwhile, high inflation forced the Federal Reserve to increase the interest rate to tamp down inflation, which hiked interest rates by three-quarters of a percentage point, or its largest rate increase since 1994.

Federal Reserve’s commitment to bringing inflation back down to its target value of 2% indicates a possibility of further interest rate hikes. The good news is that with the ease of Covid-19, the global supply chain and economic productivity would slowly recover to the pre-pandemic level. Until then, we would see a recovery in global economic growth and slower inflation pressure.

Rising Interest Rate Effects

The rising interest rate further accelerated the appreciation of U.S. dollars, as U.S. Dollar Index reached its three-year high at 104.01. Cotton is a global commodity; on average, over 80% of cotton produced in the U.S. is exported.

The appreciation of the U.S. dollar increases prices paid by foreign consumers and makes U.S. cotton less attractive. All of these indicate a retrieving of cotton prices from the peak. Since September of last year, the cotton futures market experienced an inflow of speculative money, which pushed cotton prices to levels that exceed those indicated by supply and demand fundamentals (more information here).

The flow of speculative money in and out of cotton markets makes prices unpredictable and volatile.

However, with the recent speculative money leaving the cotton market, prices fell sharply, possibly with a temporary correction below the price supported by global cotton supply and demand fundamentals.

Impact Yet To Be Seen

The impact of this year’s global cotton production on prices is yet to be seen. High cotton prices during the planting season attracted more cotton planted acres globally.

However, the Southwest United States, the major cotton-producing region in the U.S., is experiencing severe drought and is anticipating lower production this year.

U.S. Department of Agriculture June forecasted that global cotton production could reach 121.3 million bales, 4 million bales above last season and 0.2 million bales below this year’s consumption. The global ending stocks are maintained at a relatively low level at 82.7 million bales, similar to the 2017 and 2018 levels.

Depending on the production during harvest, lower cotton production in the U.S. could provide some support for cotton prices domestically.

However, with the current high global cotton production forecast, global cotton prices could drop further if the economy turns into a recession and stock markets continue to experience losses during the rest of this year.

Figure 1. December 2022 Cotton Future Prices for the Past Year (Source of the Graph: barchart.com)

Yangxuan Liu is an assistant professor of agricultural and applied economics at the University of Georgia and may be reached at Yangxuan.Liu@uga.edu.

 

 

 

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