A few years ago, some cattle producers and industry analysts raised concerns that the feeder cattle futures contract was in need of major changes and suggested even more drastic measures of delisting the contract. Much of the discussion centered around claims of unjustified variation in feeder cattle futures prices and associated basis (local cash minus nearby futures prices) volatility. Undue basis variability makes hedging in feeder cattle futures a challenge. In 2022 we published an article analyzing feeder cattle basis risk and associated determinants. The article concluded indeed during 2015 feeder cattle basis variation increased substantially as feeder cattle prices were in rapid decline following the dramatic beef cow herd expansion that was underway. Once the feeder cattle market stabilized by 2018, basis variation declined back down to levels similar to 2010-13 levels – a comforting conclusion. However, today we are on another wild ride in feeder cattle with basis variation similar to what was experienced 10 years ago but with the opposite price trend. This article summarizes what is happening and highlights what it means for market participants.
Nearby feeder cattle futures prices have doubled recently going from $130/cwt in May 2021 to more than $260/cwt in June 2024 (Figure 1). The average weekly price change was $2.70/cwt in absolute value (includes price changes due to rolling across contract months as a contract expires). In contrast, in 2015, nearby feeder cattle futures declined from $225/cwt at the start of the year to $160/cwt by year end with an absolute value of weekly price changes averaging almost $4/cwt. Since 2023, the typical weekly price move in nearby feeder futures has been close to that at $3.44/cwt up or down.
A major role of futures markets, in addition to risk transfer, is price discovery. Generally, futures markets are central to price discovery. However, research I conducted in cattle markets demonstrated that when local cattle supply conditions are rapidly changing information is often discovered first in cash markets and then transferred to futures. That is, cash markets tend to lead price discovery in these situations. But a very important aspect of local cash feeder cattle markets is because individual transactions comprised of live animals of diverse qualities are represented and bidder activity across market locations varies, price dispersion across individual transactions and auction market locations can be quite high. This means, when cattle supplies are rapidly changing and being reflected in already volatile cash transaction prices, price variation across transactions is even larger. So, both buyer and seller beware as winners and losers on both sides are more common when cash markets are leading price discovery.
Furthermore, when cash markets are rapidly changing, futures markets, because of price limits set by CME, can constrain futures prices from keeping up with cash market price changes. As such, the CME increases daily price limits on futures contracts when price variation is high. For example, in 2021 daily feeder cattle futures price limits were $6.25/cwt; they increased to $7/cwt in mid-2022; $8.25/cwt in 2023; and limits just increased to $9.25/cwt in July 2024 mirroring, with a lag, cash market price variation.
What does all this mean for market participants? It means basis risk increases when we are having a wild ride with feeder cattle markets. To illustrate, Figure 2 shows weekly nearby feeder cattle basis for 7-800 lb steers from 2015-June 2024 for five state market reports complied by USDA AMS. I selected four major cow/calf and/or feedlot states that are all part of the feeder cattle index that feeder futures settles to at expiration (NE, KS, MO, and TX) and one important cow/calf state that is not included in the index (KY). The chart has a lot of noise, but we can draw some definitive patterns.
First, basis variability across location can be stark, especially when the variation we discussed above is present in local cash market transactions. For example, during the third week of June 2024, NE basis was $29.80/cwt, meaning NE cash feeders were $29.80/cwt greater than the nearby feeder futures contract. At the other extreme of the selected markets, TX basis was -$11.66/cwt. Indicating a more than $40/cwt range between NE and TX basis that week! This is not cherry picking, as through June 2024 the weekly basis range across these five markets during this year has averaged $32.64/cwt. While NE often had the strongest basis, KY typically had the weakest. One more point here, these are the for the combined markets for these states as reported by AMS, even greater variation would be present if we examined individual auction barn sales reports.
Second,…
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