Special Report

December 12, 2024 | 09:00

Nine Key Trends Affecting Canadian Agriculture

Economist

Senior Economist and Director
Economics

Aaron analyzes performance and risk across a diverse selection of industries and countries. His research is regu... (Read more)

Aaron Goertzen , CFA

Senior Economist and Director
Economics

Aaron analyzes performance and risk across a diverse selection of industries and countries. His research is regu... (Read more)

It’s been a bumpy ride for the economy, markets, and the agriculture industry over the past few years—and that’s putting it lightly. Commodity prices, inflation, interest rates, world events, and politics have roiled the farm sector and created significant uncertainty for producers. In the spirit of trying to simplify a complex situation, this article highlights nine key economic and market trends that are having an outsized impact on Canadian agricultural producers. At the risk of spoiling the punchline, the longer-term performance of the farm sector has been in a league of its own.

Trend #1: World Economy Holding Up

Economic growth in the United States has continued to exceed expectations, allaying earlier fears about the possibility of a Fed-induced recession. Brisk growth south of the border is acting as a crucial pillar of support for the global economy, given the loss of momentum in Japan, Europe, Canada, and even China. As a result, global growth has held up relatively well despite heightened uncertainty, providing a broadly supportive demand backdrop for agricultural products and other commodities.

Although the U.S. economy is likely to downshift somewhat next year, growth should remain supported by broad-based tax cuts under the incoming Trump administration and Republican Congress. Meantime, declining interest rates should provide a growth boost in other advanced economies. The world economy is not totally out of the woods, especially with interest rates still relatively high in most countries, but global growth appears on track to accelerate slightly in 2025 as long as geopolitical and trade risks don’t spiral.

Trend #2: Abundant Crop Supplies; Livestock Leaner

Two years of relatively strong harvests have inflated global inventories of major crop products and weighed on pricing. The war in Ukraine, which initially caused a surge in crop prices, has also had less of an impact on global supply than previously feared. Prices aren’t as low as they were during the late 2010s, but costs are significantly higher today, which has made the margin environment challenging for producers. In contrast, livestock prices have trended steadily higher due to strength in the cattle space, driven by years of drought-induced declines in the North American herd.

It will take time for crop inventories to normalize, absent a crop failure. Under the assumption that growing conditions are average and yields are near trend, crop prices should stabilize and begin to regain some lost ground next year—but as always, producers are at the mercy of Mother Nature. In the livestock space, cattle producers appear to be taking initial steps toward restocking their herds, as the drought that previously afflicted large parts of cattle country has abated and feed costs are lower. Hog producers have continued to expand cautiously, suggesting continued balance in that segment.

Trend #3: Low-Flying Loonie

Although benchmark U.S. crop prices have been under heavy pressure, Canadian domestic prices have held up somewhat better due to the relatively weak loonie, which is currently trading around US$0.71. While historically steered by commodity prices, the loonie has been influenced primarily by Canada’s weaker economic performance and less hawkish monetary policy relative to the United States over the past couple years. Most recently, concern about the possibility of a trade war with the United States has added fuel to the fire. The weak Canadian dollar is acting as a broad support for domestic agricultural prices, which would likely be around 10% lower under a more neutral exchange rate. The flip side, however, is that imported inputs are also costlier.

Most factors point to continued U.S. dollar strength in the near term. More stimulative U.S. fiscal policy, a more cautious Fed, and narrower U.S. trade deficits would all be supportive of the U.S. dollar against the loonie and other currencies. However, the Canadian dollar is also trading well below purchasing power parity, which is estimated closer to US$0.80, suggesting an eventual appreciation over the medium term.

Trend #4: Expensive Inputs

Agricultural producers, like households and other businesses, have grappled with a major increase in costs over the past few years. According to Statistics Canada’s farm input price index, overall farm costs have increased by more than 35% since the beginning of 2019, reflecting broad increases across most major categories and the weakening Canadian dollar. Although fuel, fertilizer, and feed costs have come partway back to earth, other inputs have remained pricey and the overall index has remained near record highs. Farm equipment prices have been a notable pain point, as many of the most sophisticated (and expensive) agricultural implements are imported from the United States and elsewhere.

Unfortunately, when it comes to inflation, what goes up does not necessarily come down. Commodity input prices will always fluctuate, but they are unlikely to decline to the point of providing major cost relief to farmers—at least, not without a significant deterioration of the broader economy, which would also undermine farm prices. In the energy space, oil prices are expected to move slightly higher over the next year amid OPEC+ restraint and ongoing turmoil in the Middle East, though the potential for greater U.S. production poses some downside risk.

Trend #5: Interest Rates Coming Down the Mountain

To the relief of almost everyone, financing costs are moving lower. The Bank of Canada was among the first central banks to begin easing policy and has cumulatively lowered its key rate by 1.75 percentage points to 3.25% since June (putting prime at 5.45%). Longer-term fixed rates have also moved lower, albeit not in a straight line, as inflation and policy rates have declined. The five-year Government of Canada bond yield, which tends to steer private borrowing rates, has fallen by well over a percentage point from its high-water mark in late 2023.

The Bank of Canada is highly likely to continue lowering rates to shore up the economy and keep inflation near target—what we don’t know is how quickly, or how far. Although we saw half-point reductions in October and December, rate cuts are unlikely to continue at that pace unless the economic data deteriorate significantly. With wage growth still elevated, the housing market stirring, the Canadian dollar already under pressure, and the economy about to get a dose of fiscal stimulus ahead of next year’s election, a return to quarter-point cuts is probable. However, with the economy now operating below capacity, it’s likely that the Bank of Canada will not only let off the brakes but tap the gas. As a result, we have pencilled in a slightly stimulative policy rate of 2.50% by summer 2025, implying another 0.75 percentage points in cuts from here (likely putting prime at 4.70%). Longer-term fixed rates should also trend lower, though five-year borrowers will still be resetting into higher rates.

Trend #6: Looser Labour Market

Over the past couple years, the Canadian labour market has gone from generationally tight to relatively soft. The unemployment rate, after falling to a half-century low of 4.8% in mid-2022, has now increased to 6.8%, as job creation has failed to keep pace with high levels of immigration and rapid labour force growth. For businesses, this has meant that earlier labour availability challenges have fallen to the wayside, with job vacancies back to normal in the overall economy and somewhat below normal in the agriculture sector. Overall, the job market is in a much more balanced state: it is not so tight as to create labour shortages and run-away wage growth, but not so loose as to significantly undermine demand for products and services. Also on the labour front, it is notable that the farm sector has been exempted from new restrictions on Canada’s Temporary Foreign Worker program, which will hinder international hiring in other industries.

Extreme labour market tightness tends to be inflationary, so a higher jobless rate was always a precondition for the Bank of Canada to begin reducing interest rates. But with the labour market and inflation where they are today, the Bank of Canada’s new mission is to lower rates quickly enough to prevent any further deterioration. Although the jobless rate may drift somewhat higher in coming months, lower interest rates and loosening fiscal purse strings should ultimately stimulate demand and stabilize the labour market. The federal government’s plan for more moderate immigration will also temper labour force growth.

Trend #7: Trade Turmoil

As a candidate, incoming President Trump threatened to impose tariffs of 60%+ on imports from China and 10%+ on imports from other U.S. trading partners. Since being elected, he has specifically pledged to target Canada and Mexico with 25% levies unless the two countries work to tighten border security. Although there is likely an element of posturing at play, such tariffs could be expected to provoke swift retaliation and would put upward pressure on inflation while undermining economic activity. Agricultural products are frequently targeted during trade wars, and even if Canada is spared direct U.S. tariffs, trade actions by China have the potential to strand U.S. farm products in North America and depress benchmark crop prices (as occurred with soybeans in 2018). Canadian livestock producers are less at risk because overseas trade in meat products is more limited, but they are still vulnerable to direct U.S. tariffs.

There is a great deal of uncertainty about the trajectory of global trade over the next four years. On one hand, the incoming U.S. administration has clearly been emboldened by its decisive election victory, which suggests that it will not shy away from instigating trade actions. On the other hand, China may be more hesitant to retaliate against the U.S. farm sector than it was in 2018, when African swine fever had just wiped out a large portion of its hog herd, reducing its need for soybeans as feed. Within North America, there is also the possibility that President Trump will once again target Canada’s supply management system, which was a major sticking point in trade negotiations during his first administration.

Trend #8: Continued Climate Concerns

Agricultural producers are uniquely exposed to both the direct physical risks of climate change and to government efforts to reduce emissions. On the latter front, greenhouse gas emissions associated with crop and livestock production have continued to trend somewhat higher in recent years, but the longer-term increase has been negligible compared to growth in farm production. The emissions intensity of the agriculture industry, which roughly captures the volume of greenhouse gas emissions per physical unit of crop and livestock production, has fallen by nearly half since the 1990s—an impressive improvement.

Although many countries have made progress on reducing greenhouse gas emissions, most are falling short of the action that would be required to meet the targets agreed to in the Paris Accord, which calls for global average temperatures to be kept at less than 2°C above pre-industrial levels. Absent more decisive action, it seems that agricultural producers will continue to face increasingly volatile weather over the medium term. There is also considerable uncertainty about the path of climate policy within Canada, with an election due next year and polls pointing to a likely change in government.

Trend #9: Prodigious Productivity Growth

Over the longer term, the agriculture sector has posted a standout performance against an otherwise weak productivity backdrop in Canada. Since the late 1990s, total labour productivity in Canada—the main determinant of living standards—has increased by a lacklustre 31%, and it has declined outright over the past few years. In the agriculture sector, labour productivity has surged 190% over the same period, spurred by investments in technology and the adoption of new and innovative processes. Few sectors of the economy can hold a candle to that performance.

It is an admirable feat that farmers can produce nearly three times as much agricultural output per hour of labour than only a quarter century ago. And even today, producers continue to invest heavily in their operations. A short walk through a farm trade show illustrates the incredible amount of technology being deployed by both crop and livestock producers, suggesting continued outperformance ahead.