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How interest rates impact agricultural commodities – and three ways you can manage the risks

How interest rates impact agricultural commodities – and three ways you can manage the risks

For those who came of age hedging agricultural commodities during the previous decade of low to no interest rates, the last 18 months have likely been something of a shock. As interest rates have risen dramatically, a whole host of new factors have impacted agricultural commodity prices.

Issues like foreign exchange rates, exchange margins and overall market liquidity are suddenly interacting in complex ways that call for close attention, whether you’re producing those agricultural commodities or using them as inputs.

The conflict in Ukraine has compounded the situation further. As supply chain risk went up, so did the cost of hedging programs for all market participants. With interest rates rising at the same time, many discretionary participants left the market as funding for trading activities became harder to come by. Because global crops are often denominated in U.S. dollars, the rapidly strengthening U.S. currency also had a major impact.

All of this left those of us managing physical supply chains with a very different market structure: one with reduced volumes, less open interest, lower liquidity and higher volatility.

How interest rates impact agricultural commodities – imsge02

In this current context, participants who produce, process or consume agricultural commodities have a new set of variables to consider. If you’re one of these participants, here are three ways to think differently about those variables – and how Cargill Risk Management can help you keep on top of the relevant risks.

  1. Curbing exchange margins and other costs of capital

It’s no secret that the costs associated with hedging programs have gone up. Many organizations that need to hedge commodity price exposure likely have had existing processes or partners for years. Now is the time to revisit those options and see how different providers can offer more cost-effective solutions.

For instance, if a farmer is hedging an expected 100,000 bushels of corn on an exchange, they will have to post an upfront initial margin to the exchange, as well as handling a variation margin as the price moves up and down throughout the duration of the hedge. That can tie up working capital and cause heartburn.

Thanks to Cargill’s strong balance sheet, Cargill Risk Management can identify ways to help a farmer customer avoid these onerous costs. That’s because we have more than just risk management solutions – we can also work with you to build financing solutions, too. Being a physical supplier to Cargill allows us to offer even more pricing and working capital solutions. 

  1. Hedging risks in areas like interest rates, forex and more

In the previous decade, issues like interest rates and forex simply didn’t have a significant impact on prices and hedging programs compared to the more traditional forces of supply and demand. That’s no longer true. And although it seems like the world’s central banks are getting a handle on inflation, it’s likely that they could keep interests rates high for a while.

There are other twists and turns to the story that could still have an impact as well. For instance, the U.S. dollar appreciated rapidly last year, but then eased off in the past few months, creating price swings. If you need to hedge agricultural commodity prices, there could still be more chapters like this in the months ahead. Cargill Risk Management has solutions that take these exogenous forces into account.

  1. Managing supply chain partners’ exposure to de-risk your supply chain

In the low-interest-rate environment of the past, many investment grade companies asked their supply chain partners to handle their own hedging. As rates go up, those partners may not be able to bear the higher costs (see #1 above). If a supply chain partner defaults, the pricing that a company thought they were getting may already have been passed along to customers. That could sting.

What can be done? First, consider diversifying hedge providers. Second, look at credit solutions that can help protect you and those in your supply chain by freeing up working capital. Cargill Risk Management has solutions in these spaces that both investment grade companies and their supplier partners can use to de-risk up and down the supply chain.

The bottom line

So long as interest rates remain elevated, the effect on agricultural commodity markets is likely to persist. Trading volumes will be suppressed, and volatility will remain high. Talking to a partner like Cargill Risk Management can help you navigate this environment and account for all the interrelated risks described above.

Get in touch with your Cargill Risk Management contact today or learn more on our website.

These materials have been prepared by personnel in the Sales and Trading Departments of Cargill Risk Management, a business unit of Cargill, Incorporated based on publicly available sources, and is not the product of any Research Department. These materials are not research reports and are not intended as such. These materials are for the general information of our customers and are a “solicitation” only as that term is used within CFTC Rules 1.71 and 23.605, as promulgated under the U.S. Commodity Exchange Act. These materials are provided for informational purposes only and are not otherwise intended as an offer to sell, or the solicitation of an offer to purchase, any swap, security or other financial instrument. These materials contain preliminary information that is subject to change and that is not intended to be complete or to constitute all of the information necessary to evaluate the consequences of entering into a swap transaction and/ or investing in any securities or other financial instruments described herein. These materials also include information obtained from sources believed to be reliable, but Cargill Risk Management does not warrant their completeness or accuracy. In no event shall Cargill Risk Management be liable for any use by any party of, for any decision made or action taken by any party in reliance upon, or for any inaccuracies or errors in, or omissions from, the information contained in these materials and such information may not be relied upon by you in evaluating the merits of participating in any transaction. All projections, forecasts and estimates of returns and other “forward-looking” information not purely historical in nature are based on assumptions, which are unlikely to be consistent with, and may differ materially from, actual events or conditions. Such forward-looking information only illustrates hypothetical results under certain assumptions. Actual results will vary, and the variations may be material. Nothing herein should be construed as an investment recommendation or as legal, tax, investment or accounting advice. Cargill Risk Management is a provisionally registered Swap Dealer and operates under “Order of Limited Purpose Designations for Cargill, Incorporated and an Affiliate.”