November 08, 2022

Export Q & A: Dollar's Strength Leads Economic Headwinds

Q: I have been negotiating with a few buyers from the Midwest Buyer’s Mission in July. Over the last few weeks they have all said I need to lower my export price up to 40% just to compete. That is below my cost and my export prices are netted out with a modest margin, selling well in the past. If buyers cannot afford our products U.S. exports must be slowing down. What is causing all this to happen? 

A: It sounds like those buyers are in countries where their currencies have devalued against the U.S. dollar, but there are other challenges as well. As the old saying goes, managing global economics is like trying to walk twelve dogs at the same time. There is a lot going on in the world today which is causing uncertainty and very concerning for how to manage our way through it. Cycles do come and go of course, but at the moment, the dogs are barking loud and not cooperating with one another. Let’s run through the latest developments, including the latest U.S. food export data which remains positive.

U.S. agricultural export data was just released is available through September 2022, which marks three quarters of the year. There is still significant record growth in value at $144 billion, an increase of 16% year to date (YTD). In 2011 the total for the year was $142.1 billion and we are over that amount still with three months to count so this is remarkable. Much of the YTD increase comes from the bulk commodity aggregate which totaled YTD $53.7 billion, an increase of 26%. This represents 37.2% of the agricultural total, and 86% of the consumer-oriented total. In 2021 YTD those figures were 34.4% of the AG total and 75%, so you can see that the increase prices for commodities again have grown more than their respective volume. In 2021 YTD consumer food exports were $15 billion higher than bulk, and in 2022 through September they are only $9 billion higher. Mexico pays an average of 6% more YTD for a ton of corn, Japan 15% more, and Costa Rice a whopping 30% more as examples.

U.S. consumer food exports totaled $62.6 billion, growth of 10% YTD and processed food exports, (many of which are double counted with consumer oriented, reached $39.8 billion YTD, matching consumer foods with growth of 10%. Only three out of 19 processed commodity aggregates are in decline including the top one, Food Preparations and Ingredients, down only 3% to $5.3 billion YTD, Prepared/Preserved Seafood down only 4% to $1.8 billion, and the bottom aggregate which is Processed Egg Products down 16% to $70 million.    

USDA’s Economic Research Service (ERS) published its most recent “Outlook for U.S. Agricultural Trade” in late August. There may be some clues as to the future of our food exports which have been breaking monthly, quarterly and annual records during the last three years. First it reports that U.S. agricultural exports in fiscal year (FY) 2023 are projected at $193.5 billion, not up but down $2.5 billion from the revised forecast for FY 2022. This decrease is primarily driven by lower exports of cotton, beef, and sorghum that are partially offset by higher exports of soybeans and horticultural products. Certain sectors also face drought-slashed exportable values, overall tightening supplies or at least those made for export, and some prices of commodities are also dropping, facing inflationary realities as well as that of a strengthening dollar.

The dollar rose against all other major currencies at the end of 2014 for the first time since the turn of the century, as investors expecting interest rates to rise stored their assets in USD$. Total U.S. agricultural exports in 2015 dropped $17.3 billion or 11% as U.S. products became much more expensive to convert local currencies into dollar for repayment.

Of note, agricultural exports to China are softening slightly, forecast at $36 billion, unchanged from FY 2022, as higher soybean exports offset lower cotton and sorghum prospects. Agricultural exports to Canada and Mexico are forecast at $28.5 billion each, also unchanged from FY 2022. So for the first time since the trade war with China ended and the “Phase One” agreement began, export of agricultural products to China are not in a high growth mode.

Economic Headwinds in the Medium Term
The International Monetary Fund (IMF) reports that global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than seen in several decades. The cost-of-living crisis, tightening financial conditions in most regions, Russia’s invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on the outlook. Global growth is forecast to slow from 6% percent in 2021 to 3.2% in 2022 and 2.7% in 2023. This is the weakest growth profile since the global recession in 2001 except for the global financial crisis and the acute phase of the COVID-19 pandemic.

The IMF reports that projected growth for the United States’ real GDP in 2022 is lowered to 2.3% from the previous estimate of 3.7%. The forecast for 2023 real U.S. GDP growth is only 1%, partially due to persistently high inflation. The July 2022 Consumer Price Index (CPI) showed prices had increased by 8.5% over the past 12 months, down from the higher year-over year mark of 9.1% in June. The Federal Reserve has reaffirmed its intention to continue its scheduled interest rate hikes given above-target inflation and the low unemployment rate, which was last measured at 3.7% in October 2022 by the U.S. Department of Labor, Bureau of Labor Statistics. The Federal Reserve on Wednesday November 2nd hiked its key interest rate by another 0.75%. Their meeting summary reported "Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures," the Fed said in its statement Wednesday. It added it is "strongly committed to returning inflation to its 2% objective."  

And then of course we have the issue of recession which is a likely outcome of The U.S. Fed raising interest rates to cool the economy which also unfortunately raises the unemployment rate, which is currently an impressive 3.5%.  Former Treasury Secretary Lawrence Summers is quoted by the Southern California News Group as saying “over the past 75 years, every time inflation has exceeded 4% and unemployment has been below 5% the U.S. economy has gone into recession within 2 years. Today, inflation is north of 6% and unemployment is south of 4%”. He advised unemployment would have to go above 6% to achieve some significant inflation reduction.

Ocean Freight Prices
Thankfully, supply chain complications have slowly abated, but “spot” (non-published) shipping rates remain higher than pre-pandemic levels. Ocean freight carries more than 80% of the world’s traded goods, most of which sail inside 20 or 40-foot-long steel containers stacked by the thousands atop some of the largest vessels ever built.

The IMF reported that the shock of the pandemic underscored just how crucial the maritime container trade is to the global economy. From Shanghai to Rotterdam to Los Angeles, the coronavirus upended supply chains. Ports lacked workers who were home sick. Truck drivers and ship crews couldn’t cross borders because of public health restrictions. Pent-up demand from huge stimulus programs during extended lockdowns overwhelmed the capacity of supply chains. Besides causing delays in getting goods to customers, the cost of getting them there surged.

While the pass-through period to inflation is less than that associated with fuel or food prices—which account for a larger share of consumer purchases—shipping costs are much more volatile. As a result, the contribution in the variation of inflation due to global shipping price changes is quantitatively similar to the variation generated by shocks to global oil and food prices.  They found that those higher shipping costs hit prices of imported goods at the dock within two months, and quickly pass through to producer prices—many of whom rely on imported inputs to manufacture their goods. But the impact on the prices consumers pay at the cash register builds up more gradually, hitting its peak after 12 months. This is a much slower process than what is seen after a rise in global oil prices, which drivers feel at the pump within a couple of months.

Their results suggest the inflationary impact of shipping costs will continue to build through the end of 2022. This will create complicated trade-offs for many central bankers facing increasing inflation and still ample slack in economic activity. Moreover, the war in Ukraine is likely to cause further disruptions to supply chains, which could keep global shipping costs—and their inflationary effects—higher for longer.

Maersk: A Barometer for Global Trade
MSNBC reports that the Danish shipping giant, widely seen as a barometer for global trade, reported earnings before interest, taxes, depreciation and amortization of $10.9 billion for the 3rd quarter.  CEO Soren Skou said the "exceptional results" were driven by a continued rise in ocean freight rates, but said it was clear that these have peaked and will begin to normalize in the fourth quarter amid falling demand and an easing of supply chain congestion. Skou flagged that earnings in Maersk's ocean operations will come down in the coming months.

"With the war in Ukraine, an energy crisis in Europe, high inflation, and a looming global recession there are plenty of dark clouds on the horizon," Skou said in a statement. "This weighs on consumer purchasing power which in turn impacts global transportation and logistics demand. While we expect a slow-down of the global economy to lead to a softer market in Ocean, we will continue to pursue the growth opportunities within our Logistics business." The company said Wednesday that global container demand is expected to contract between 2% and 4% in 2022, down from a previous projection of +1% to -1%, noting that freight and charter rates declined in the third quarter as demand moderated and Chinese Covid-19 restrictions diminished.

The Strength of the U.S. Dollar
Perhaps the most significant challenge for U.S. exporters on a macro level is the relative strengthening of the dollar against other foreign currencies. The dollar is at its highest level since 2000, having appreciated 22% against the yen, 13% against the Euro and 6% against emerging market currencies since the start of this year. Such a sharp strengthening of the dollar in a matter of months has sizable macroeconomic implications for almost all countries, given the dominance of the dollar in international trade and finance. But is especially challenges U.S. export growth as the already inflated prices now become even more expensive when the local currency must be exchanged into U.S. dollars for payment to the supplier. Many of these increases are actually higher than the duties and taxes on the products being imported.

While the U.S. share in world merchandise exports has declined from 12% to 8% since 2000, the dollar’s share in world exports has held around 40%. For many countries fighting to bring down inflation, the weakening of their currencies relative to the dollar has made the fight harder. On average, the estimated pass-through of a 10%-dollar appreciation into inflation is 1%. These pressures are especially evident in emerging markets, reflecting their higher import dependency and greater share of dollar-invoiced imports compared with advanced economies.

In addition to currency devaluation of the Yen, Euro and emerging market currencies, the following countries’ currencies have also weakened in the exchange rate with the “greenback”. They include Canada, Australia, South Korea, U.K., Indonesia, Colombia, India, Malaysia, China, Chile, Philippines, Poland, and Turkey, which has suffered the most at over 30% devaluation. Not all countries’ currencies have weakened in 2022 however.  The Brazilian Real, The Peruvian Nuevo Sol (PEN), and Mexican Peso have all strengthened over the course of the year.

According to the IMF, as of now, economic fundamentals are a major factor in the appreciation of the dollar: the rapid rise U.S. interest rates and a more favorable terms-of-trade—a measure of prices for a country’s exports relative to its imports—for the U.S. caused by the energy crisis. Fighting a historic increase in inflation, the Federal Reserve has embarked on a rapid tightening path for policy interest rates. The European Central Bank, while also facing broad-based inflation, has signaled a shallower path for their policy rates, out of concern that the energy crisis will cause an economic downturn. Meanwhile, low inflation in Japan and China has allowed their central banks to buck the global tightening trend.

The massive terms-of-trade shock triggered by Russia’s invasion of Ukraine is the second major driver behind the dollar’s strength. The euro area (countries adopting the currency) is highly reliant on energy imports, in particular natural gas from Russia. The surge in gas prices has brought its terms of trade to the lowest level in the history of the shared currency.

Trade Deficit with Food Imports
Another effect of a stronger dollar is that it makes imports more affordable, including food and agricultural products. When the ERS outlook mentioned that U.S. agricultural exports in fiscal year (FY) 2023 are projected at $193.5 billion, down $2.5 billion from the revised forecast for FY 2022, they also reported that the forecast for imports will reach $197 billion. That is what is known as a “trade deficit”, when we import more of products from countries than we export to them.

Historically the U.S. has had a strong trade surplus with the world, only occasionally getting closer and once in a while it will happen for a month or two during the year. It also took place in 2019 and 2020 but was not estimated to do so. A forecast deficit projection for a fiscal year is concerning, and also a result of increased buying power of importers and consumers of imported products. U.S. exports of agricultural products in September of 2022 totaled $13.6 billion. U.S. imports of agricultural products added up to nearly $15.9 billion, for a deficit of nearly $2.3 billion.  In fact, it looks like the U.S. will have a trade deficit for calendar year 2022, even with another record high level of value. YTD (Sept.) exports were $144 billion with 16% growth as mentioned earlier, but U.S. imports of food and agricultural products have grown 19% to $149.1 billion.

Your buyers would be very happy if they were exporting food instead of importing it, based on our growth in consumption. Once they have to pay in dollars though, many consumer and processed food products will seem quite expensive in many markets for the time being. As mentioned, that is the likely scenario the buyers you are negotiating with are experiencing. Many of the dogs are barking right now, but the strong dollar may be barking the loudest.