Six Key Macroeconomic Trends Affecting Canadian Agriculture
It’s been an eye-opening few years for the economy, to say the least. Since the turn of the decade we have seen pandemic lockdowns, unprecedented economic stimulus, an ongoing war in Ukraine, wild swings in commodity prices, and a multi-decade surge in inflation and interest rates. And if that weren’t enough, it looks as though the North American economy could tip into a mild recession this year.
The volatile economic environment has created substantial uncertainty about the future for households and businesses. In the spirit of trying to make this complex situation a little bit clearer, this article lays out six key macroeconomic trends that are expected to have an outsized impact on Canadian agricultural producers ahead.
Trend #1: Cost Pressures to Diminish
The surge in inflation over the past couple of years has left few corners of the economy untouched, but the agriculture sector has faced a particularly harrowing increase in costs. Statistics Canada estimates that the overall price of farm inputs jumped 29% between the end of 2019 (just before the pandemic) and the end of 2022 (the latest available data) (Chart 1). Virtually all individual farm inputs became significantly more costly over that period, but fertilizer led the way higher (+85%) due to rising production costs, strong global demand, and tariffs put in place on Russia due to its aggression in Ukraine. Higher fuel costs have been another pressure point (+53%), while higher feed costs (+56%) have weighed further on livestock margins. The cost of buildings (+22%) and machinery and vehicles (+21%) increased less than the total, but still a large amount over a relatively short period.
Fortunately, the increase in costs has so far been offset by the higher price of agricultural commodities. Statistics Canada’s farm commodity price index increased 49% between the end of 2019 and 2022, though margin developments have varied widely by segment. In the crop space, an especially large increase in selling prices (+66%) has yielded significantly wider operating margins and a big increase in earnings. Livestock producers have experienced a more moderate increase in selling prices (+25%) as well as greater cost pressure, given the jump in feed costs and the drought on the prairies, which has restrained profit margins by comparison.
At this point, it looks as though the worst of the cost increases has passed. Early 2023 estimates, which are not geared specifically to the farm sector but are available on a timelier basis, are showing a significant decline in the price of diesel, and to a lesser extent fertilizer. And, with the economy slowing as policymakers attempt to corral inflation back to the 2% target, costs should continue to cool. However, input prices are unlikely to return to pre-pandemic levels—and even as they begin to edge lower, the key question for farmers will be the extent to which selling prices follow suit. Already, crop prices have turned lower as concerns about the state of the economy have come to the fore.
Trend #2: Labour Market to Loosen
The labour market, like the rest of the economy, rebounded impressively from the pandemic. The unemployment rate, after peaking above 14% in the spring of 2020, declined rapidly as the economy reopened and has been hovering near fifty-year lows of around 5% over the past year. The strong job market has naturally been a welcome development for workers, but it has also created major labour availability challenges for businesses. The Canadian Federation of Independent Business estimates that almost 5% of positions in the agriculture sector are currently unfilled, which is the highest level in at least two decades (Chart 2). Labour shortages have also put upward pressure on wages, which have added to the other cost pressures facing farms. The challenge has been particularly acute for more labour-intensive segments like fruit and vegetable production.
Fortunately, there are some early signs that labour market conditions are beginning to normalize. Although the unemployment rate remains exceptionally low, job vacancies have started to decline, which is improving labour availability. This trend is likely to persist over the next few quarters, because by design, the Bank of Canada’s high interest rate policy is intended to introduce more slack into the overheated economy. The higher interest rate environment is expected to raise the unemployment rate closer to 6% by the end of the year, which would be more consistent with moderate wage growth and the Bank of Canada’s inflation target.
Trend #3: Weaker Economy to Hinder Demand
Today’s elevated interest rates are intended to bring total demand for goods and services into better alignment with supply, which will help to slow inflation. In an ideal world, central banks would accomplish this alignment by carefully engineering slower demand growth (as opposed to provoking an outright decline) so that the capacity of the economy has time to catch up. However, such “soft landings” are much more difficult to achieve when central banks are slow in their initial response to inflation, as most were last year. At the beginning of 2022, both Canada and the U.S. had unemployment nearing multi-decade lows, inflation nearing multi-decade highs, and yet policy rates were still pinned at effectively zero. In order to catch up to the situation, both the Bank of Canada and the Fed were forced to unleash a rapid-fire sequence of large interest rate increases. Better late than never—but, since it can take up to a year or two for changes in interest rates to have their full impact on the economy, it’s easy to overdo things when rates are raised quickly.
With a huge amount of monetary tightening still working its way through the economy and U.S. regional banking stress likely to lead to more cautious lending, it seems unlikely that North America will avoid a mild recession this year. And, while major overseas economies appear to be doing a bit better, it’s clear that global economic growth is slowing, which is a negative for farm product demand. Of course, people always need to eat, so agricultural demand is not especially sensitive to economic conditions. But agricultural supply is essentially fixed over short periods, because today’s production levels were decided months or even years ago (in the case of cattle). As a result, even small shifts in demand can have a big impact on farm prices. As a reference point, overall farm commodity prices declined 18% in Canada during the 2008-09 recession (Chart 3), reflecting large declines in both crop and livestock products. That recession was far worse than anything expected ahead, but just the risk of a potential downturn already appears to be weighing on some agricultural markets.
Trend #4: No Immediate Relief on Rates
The Bank of Canada, in its quest to bring inflation back under control, raised its policy rate from an emergency setting of 0.25% at the beginning of 2022 to 4.5% in early 2023 (Chart 4). This represents an immense amount of tightening in the span of less than a year, and raised the prime rate from 2.45% to 6.7%—the highest since the early 2000s. Longer-term market interest rates have also increased dramatically from their pandemic-era lows. The five-year Government of Canada bond yield, which has a large influence on commercial fixed interest rates, has jumped from less than 0.40% in 2020 to around 3% today. Given the capital-intensive nature of agricultural production, higher interest rates are a clear negative for earnings. They also represent a potential negative for farmland prices, though the impact has so far been countered by strong farm product prices.
Encouragingly, recent progress on inflation has allowed the Bank of Canada to announce a “conditional pause” on policy. Its hope is that today’s interest rates will eventually be enough to control inflation, and it believes that raising rates further would risk undue damage to the economy. However, it’s unlikely that cuts are right around the corner, since it will take time for inflation to return all the way to the 2% target, and policymakers have been clear that they will not accept anything higher. The last thing that Bank of Canada wants to do is lower rates prematurely and reignite inflation. Rate cuts are therefore likely to be a 2024 story.
Trend #5: Canadian Dollar to Remain Supportive
The past couple of years have brought some unexpected developments for the Canadian dollar, most notably its untethering from the price of oil. Historically, the loonie has moved basically in lockstep with North American oil prices, reflecting the large share of oil in Canadian exports (Chart 5). Had the usual relationship held, the surge in oil prices to an average of $95 U.S. per barrel last year would have been expected to lift the loonie to roughly parity against the U.S. dollar. But commodities haven’t been the only thing in flux, and the U.S. dollar has benefitted significantly from Federal Reserve rate hikes and concern about the state of the world economy, which has increased safe-haven demand for U.S. assets. For the loonie, the broad U.S. dollar strength entirely offset the lift from commodities, keeping it range-bound around $0.75 U.S. Even today, oil prices remain elevated by pre-pandemic norms at around $70 per barrel, while the Canadian dollar remains below longer-term norms.
The low-flying loonie has been a boon for resource producers in general and farmers in particular. Like most commodities, agricultural products are generally priced in U.S. dollars, so the weak Canadian dollar has allowed Canadian farmers to repatriate their revenue into far more domestic currency. The higher cost of imported inputs has only partly offset that windfall. Looking ahead, it wouldn’t be surprising to see the loonie rise a few cents as the Federal Reserve stops raising rates, but ongoing concern about the economy should keep the U.S. dollar generally well supported. The Canadian dollar should therefore remain at a favourable level from the standpoint of the farm sector.
Trend #6: Deglobalization an Ongoing Challenge
Canadian agricultural producers have increasingly expanded into foreign markets over the past few decades. In 2022, exports of raw agricultural products increased to a record high of $37 billion (or around 42% of total farm sales), while exports of processed food products reached $53 billion, providing a large source of indirect demand to domestic farms. Like most export-oriented industries in Canada, the farm sector sells primarily into the United States, but other markets have grown significantly in importance—and none faster than China. Exports to China increased from less than 1% of farm sales in 2002 to a peak of more than 10% in 2018 (Chart 6).
Clearly, the farm sector has benefited enormously from globalization, but reliance on foreign markets also has its risks. The agricultural industry has always been vulnerable to trade disputes, so greater reliance on export markets has naturally put a larger share of farm revenue at risk. But, whereas restrictions on agricultural trade have traditionally been motivated by governments’ desire to protect domestic farmers, the recent disputes have been more geopolitical in nature. In 2019, after Canada’s detention of a Chinese business executive, China suspended most purchases of Canadian canola, the country’s largest revenue-generating crop. Exports plummeted overnight, carving almost 7% from farm revenue, and the ban was only lifted in 2022.
Unfortunately, the geopolitical environment has only become more fraught, with China and the West increasingly rattling sabres over issues ranging from technology to Taiwan. In this environment, China has become more wary of its dependence on imported food products and is increasingly focused on food security, which could weigh on future trade flows. Russia’s invasion of Ukraine has sent additional shockwaves through the farm sector. As a silver lining, Canadian farmers have benefitted from higher crop prices due to war-related shortages, but fertilizer costs have soared, highlighting cost-side vulnerability. At this stage, it’s too early to know whether deteriorating relations between major powers will put globalization permanently into reverse, but few industries would be more affected than agriculture by a fragmenting of the world economy.
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Aaron Goertzen
Director, Senior Economist
Aaron analyzes performance and risk across a diverse selection of industries and countries. His research is regularly distributed to clients and the media and is al…(..)
View Full Profile >It’s been an eye-opening few years for the economy, to say the least. Since the turn of the decade we have seen pandemic lockdowns, unprecedented economic stimulus, an ongoing war in Ukraine, wild swings in commodity prices, and a multi-decade surge in inflation and interest rates. And if that weren’t enough, it looks as though the North American economy could tip into a mild recession this year.
The volatile economic environment has created substantial uncertainty about the future for households and businesses. In the spirit of trying to make this complex situation a little bit clearer, this article lays out six key macroeconomic trends that are expected to have an outsized impact on Canadian agricultural producers ahead.
Trend #1: Cost Pressures to Diminish
The surge in inflation over the past couple of years has left few corners of the economy untouched, but the agriculture sector has faced a particularly harrowing increase in costs. Statistics Canada estimates that the overall price of farm inputs jumped 29% between the end of 2019 (just before the pandemic) and the end of 2022 (the latest available data) (Chart 1). Virtually all individual farm inputs became significantly more costly over that period, but fertilizer led the way higher (+85%) due to rising production costs, strong global demand, and tariffs put in place on Russia due to its aggression in Ukraine. Higher fuel costs have been another pressure point (+53%), while higher feed costs (+56%) have weighed further on livestock margins. The cost of buildings (+22%) and machinery and vehicles (+21%) increased less than the total, but still a large amount over a relatively short period.
Fortunately, the increase in costs has so far been offset by the higher price of agricultural commodities. Statistics Canada’s farm commodity price index increased 49% between the end of 2019 and 2022, though margin developments have varied widely by segment. In the crop space, an especially large increase in selling prices (+66%) has yielded significantly wider operating margins and a big increase in earnings. Livestock producers have experienced a more moderate increase in selling prices (+25%) as well as greater cost pressure, given the jump in feed costs and the drought on the prairies, which has restrained profit margins by comparison.
At this point, it looks as though the worst of the cost increases has passed. Early 2023 estimates, which are not geared specifically to the farm sector but are available on a timelier basis, are showing a significant decline in the price of diesel, and to a lesser extent fertilizer. And, with the economy slowing as policymakers attempt to corral inflation back to the 2% target, costs should continue to cool. However, input prices are unlikely to return to pre-pandemic levels—and even as they begin to edge lower, the key question for farmers will be the extent to which selling prices follow suit. Already, crop prices have turned lower as concerns about the state of the economy have come to the fore.
Trend #2: Labour Market to Loosen
The labour market, like the rest of the economy, rebounded impressively from the pandemic. The unemployment rate, after peaking above 14% in the spring of 2020, declined rapidly as the economy reopened and has been hovering near fifty-year lows of around 5% over the past year. The strong job market has naturally been a welcome development for workers, but it has also created major labour availability challenges for businesses. The Canadian Federation of Independent Business estimates that almost 5% of positions in the agriculture sector are currently unfilled, which is the highest level in at least two decades (Chart 2). Labour shortages have also put upward pressure on wages, which have added to the other cost pressures facing farms. The challenge has been particularly acute for more labour-intensive segments like fruit and vegetable production.
Fortunately, there are some early signs that labour market conditions are beginning to normalize. Although the unemployment rate remains exceptionally low, job vacancies have started to decline, which is improving labour availability. This trend is likely to persist over the next few quarters, because by design, the Bank of Canada’s high interest rate policy is intended to introduce more slack into the overheated economy. The higher interest rate environment is expected to raise the unemployment rate closer to 6% by the end of the year, which would be more consistent with moderate wage growth and the Bank of Canada’s inflation target.
Trend #3: Weaker Economy to Hinder Demand
Today’s elevated interest rates are intended to bring total demand for goods and services into better alignment with supply, which will help to slow inflation. In an ideal world, central banks would accomplish this alignment by carefully engineering slower demand growth (as opposed to provoking an outright decline) so that the capacity of the economy has time to catch up. However, such “soft landings” are much more difficult to achieve when central banks are slow in their initial response to inflation, as most were last year. At the beginning of 2022, both Canada and the U.S. had unemployment nearing multi-decade lows, inflation nearing multi-decade highs, and yet policy rates were still pinned at effectively zero. In order to catch up to the situation, both the Bank of Canada and the Fed were forced to unleash a rapid-fire sequence of large interest rate increases. Better late than never—but, since it can take up to a year or two for changes in interest rates to have their full impact on the economy, it’s easy to overdo things when rates are raised quickly.
With a huge amount of monetary tightening still working its way through the economy and U.S. regional banking stress likely to lead to more cautious lending, it seems unlikely that North America will avoid a mild recession this year. And, while major overseas economies appear to be doing a bit better, it’s clear that global economic growth is slowing, which is a negative for farm product demand. Of course, people always need to eat, so agricultural demand is not especially sensitive to economic conditions. But agricultural supply is essentially fixed over short periods, because today’s production levels were decided months or even years ago (in the case of cattle). As a result, even small shifts in demand can have a big impact on farm prices. As a reference point, overall farm commodity prices declined 18% in Canada during the 2008-09 recession (Chart 3), reflecting large declines in both crop and livestock products. That recession was far worse than anything expected ahead, but just the risk of a potential downturn already appears to be weighing on some agricultural markets.
Trend #4: No Immediate Relief on Rates
The Bank of Canada, in its quest to bring inflation back under control, raised its policy rate from an emergency setting of 0.25% at the beginning of 2022 to 4.5% in early 2023 (Chart 4). This represents an immense amount of tightening in the span of less than a year, and raised the prime rate from 2.45% to 6.7%—the highest since the early 2000s. Longer-term market interest rates have also increased dramatically from their pandemic-era lows. The five-year Government of Canada bond yield, which has a large influence on commercial fixed interest rates, has jumped from less than 0.40% in 2020 to around 3% today. Given the capital-intensive nature of agricultural production, higher interest rates are a clear negative for earnings. They also represent a potential negative for farmland prices, though the impact has so far been countered by strong farm product prices.
Encouragingly, recent progress on inflation has allowed the Bank of Canada to announce a “conditional pause” on policy. Its hope is that today’s interest rates will eventually be enough to control inflation, and it believes that raising rates further would risk undue damage to the economy. However, it’s unlikely that cuts are right around the corner, since it will take time for inflation to return all the way to the 2% target, and policymakers have been clear that they will not accept anything higher. The last thing that Bank of Canada wants to do is lower rates prematurely and reignite inflation. Rate cuts are therefore likely to be a 2024 story.
Trend #5: Canadian Dollar to Remain Supportive
The past couple of years have brought some unexpected developments for the Canadian dollar, most notably its untethering from the price of oil. Historically, the loonie has moved basically in lockstep with North American oil prices, reflecting the large share of oil in Canadian exports (Chart 5). Had the usual relationship held, the surge in oil prices to an average of $95 U.S. per barrel last year would have been expected to lift the loonie to roughly parity against the U.S. dollar. But commodities haven’t been the only thing in flux, and the U.S. dollar has benefitted significantly from Federal Reserve rate hikes and concern about the state of the world economy, which has increased safe-haven demand for U.S. assets. For the loonie, the broad U.S. dollar strength entirely offset the lift from commodities, keeping it range-bound around $0.75 U.S. Even today, oil prices remain elevated by pre-pandemic norms at around $70 per barrel, while the Canadian dollar remains below longer-term norms.
The low-flying loonie has been a boon for resource producers in general and farmers in particular. Like most commodities, agricultural products are generally priced in U.S. dollars, so the weak Canadian dollar has allowed Canadian farmers to repatriate their revenue into far more domestic currency. The higher cost of imported inputs has only partly offset that windfall. Looking ahead, it wouldn’t be surprising to see the loonie rise a few cents as the Federal Reserve stops raising rates, but ongoing concern about the economy should keep the U.S. dollar generally well supported. The Canadian dollar should therefore remain at a favourable level from the standpoint of the farm sector.
Trend #6: Deglobalization an Ongoing Challenge
Canadian agricultural producers have increasingly expanded into foreign markets over the past few decades. In 2022, exports of raw agricultural products increased to a record high of $37 billion (or around 42% of total farm sales), while exports of processed food products reached $53 billion, providing a large source of indirect demand to domestic farms. Like most export-oriented industries in Canada, the farm sector sells primarily into the United States, but other markets have grown significantly in importance—and none faster than China. Exports to China increased from less than 1% of farm sales in 2002 to a peak of more than 10% in 2018 (Chart 6).
Clearly, the farm sector has benefited enormously from globalization, but reliance on foreign markets also has its risks. The agricultural industry has always been vulnerable to trade disputes, so greater reliance on export markets has naturally put a larger share of farm revenue at risk. But, whereas restrictions on agricultural trade have traditionally been motivated by governments’ desire to protect domestic farmers, the recent disputes have been more geopolitical in nature. In 2019, after Canada’s detention of a Chinese business executive, China suspended most purchases of Canadian canola, the country’s largest revenue-generating crop. Exports plummeted overnight, carving almost 7% from farm revenue, and the ban was only lifted in 2022.
Unfortunately, the geopolitical environment has only become more fraught, with China and the West increasingly rattling sabres over issues ranging from technology to Taiwan. In this environment, China has become more wary of its dependence on imported food products and is increasingly focused on food security, which could weigh on future trade flows. Russia’s invasion of Ukraine has sent additional shockwaves through the farm sector. As a silver lining, Canadian farmers have benefitted from higher crop prices due to war-related shortages, but fertilizer costs have soared, highlighting cost-side vulnerability. At this stage, it’s too early to know whether deteriorating relations between major powers will put globalization permanently into reverse, but few industries would be more affected than agriculture by a fragmenting of the world economy.
This is part 1
of a
2-part series on
2023 Agriculture Economic Outlook
PART 2
To Get Through the Economic Turmoil, Make Sure You Know Your Numbers
June 12, 2023 Agriculture, Economic Insights
Rising input costs, a tight labour market and land price uncertainty are increasing the cost of operating a farm. Meanwhile, as BMO Senior Economist …
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