Understanding live cattle price volatility
March 17, 2016
Cattle buyers and sellers have been experiencing a fluctuation of sorts, not just in the live cattle markets over the last eight months but also in their within-day trades.
The live cattle market volatility in the last year, but particularly in the last eight months, shows a major downturn in price, explained Kansas State University livestock economist Ted Schroeder. For example, live fed steers have gone from selling in the mid-$160s per hundredweight (cwt) about this time a year ago, dropped all the way to $115/cwt in late December 2015 and averaged $137/cwt the week of March 11, according to the U.S. Department of Agriculture's Agricultural Marketing Service.
"That magnitude of price movement across just a few months and that kind of volatility is something we haven't seen historically in terms of total dollar magnitude in fed cattle markets," Schroeder said.
Buyers and sellers are also experiencing within-day volatility in the futures market and the sometimes wide range of prices between the high and low price for the day, he said.
“Anytime a market is in rapid movement, whether it’s upward or downward movement, there’s going to be a tendency for within-day variability to also escalate. The market is grappling to some extent for the latest information. Transactions, as a result, end up with more volatility within the day, because there’s a lot of uncertainty about where the market is going next.” Ted Schroeder, Kansas State University livestock economist
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"Anytime a market is in rapid movement, whether it's upward or downward movement, there¹s going to be a tendency for within-day variability to also escalate," Schroeder said.
Part of the reason for this is market participants are looking forward and contemplating where the market is headed as they negotiate trades. They are anticipating market direction without full information, and information is flowing at an accelerated rate.
"The market is grappling to some extent for the latest information," Schroeder said. "Transactions, as a result, end up with more volatility within the day, because there's a lot of uncertainty about where the market is going next."
Areas of uncertainty
Part of the uncertainty comes from price discovery, which happens as information is gathered. Schroeder said those who are selling are using the knowledge they have to establish an asking price, and those who are buying are trying to put together a bid price. The collective information each side has is used to generate an agreeable transaction price.
When the market is experiencing rapid movements, whether in domestic supply and demand or in exports, those who are involved in that market buyers and sellers are both striving to try to figure out where the next price is, day to day and within the day, he said.
Then there's the question about who is using cash trade information for price discovery and in what ways, Schroeder said, adding that there has been a recent reduction in the number of cash transactions being negotiated in the live cattle market.
"When we reduce the volume of trade that's establishing the price in the market, as we¹ve done in a big way in the cattle market over the last three years or so, we¹re reducing the amount of information that¹s being impounded into that price," he said. "Transactions themselves create information for the trade, so part of this goes back to the cash trade. Information flows both directions between futures and cash."
Fewer transactions and a spottier trade environment have led to other concerns as well, Schroeder said. In the last eight months, some buyers have witnessed situations where cattle on negotiated trade were getting too heavy partly because sellers could continue to take advantage of low feed costs and feed cattle while waiting for the right time to sell.
High-frequency and large-volume trading
The presence of high-frequency electronic trading, or exchanges in the market that occur rapidly, can influence within-day price variability, Schroeder said, especially if these rapid exchanges are large in volume.
"To get another trade executed on the other side of that large trade, the market may have to move before that next trade is executed," he explained. "The fact that large volume trading may be occurring more quickly could add a little more volatility."
However, from the data he's seen that CME Group has shared, high-frequency trading in live cattle has for the most part not been of large volume, even during some of the most volatile trading days. On average, 10 percent of the volume is of high-frequency trade in the live cattle market, according to the CME Group estimates.
Schroeder added that any type of trade whether high or low frequency, large or small volume increases liquidity in a futures market.
"That's the ability of you as a seller to rapidly make a sale order without having the price go down to do it or me as a buyer to be able to buy without having to make the price go up to get that transaction to occur," Schroeder said.
"If you have large volumes of trade on both sides of that market occurring, you can easily make that trade without forcing price to move for your trade to occur," he continued. "While high-frequency trading could add to variability within the day, it also provides liquidity for those who do want to make a trade quickly without a lot of slippage in that market."
Advice to buyers and sellers
The best advice Schroeder has for cattle buyers and sellers in the current market is to stick with a plan.
"If you're placing the hedge, place it as soon as you've established the feeder cattle purchase price," he said. "Don't wait two days, because who knows where you will be. If you¹re doing this in the morning, don¹t wait until the afternoon. You can't work off averages; an hour from now that average could be at a different point. There's that much variability."
Schroeder said he doesn't think this is a new normal in the cattle markets but is mainly due to current uncertainty. However, the variability is probably not going away for a while.
For more information and the latest updates about the cattle market, visit K-State¹s Department of Agricultural Economics website, http://agmanager.info.