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 In mid-February 2020, a sharp drop in soybean market liquidity
(in particular, the ease with which traders could buy or sell
large future positions) coincided with news reports of a
ten-fold increase in the number of deaths attributed to the
pandemic in China, which is a major export market for U.S.
oilseeds.
“The biggest source of demand worldwide for soybeans is in
China. So it was not necessarily surprising the things that
matter for the Chinese economy would impact soybeans first,”
states Michel Robe, the Clearing Corp. Charitable Foundation
Professor in Derivatives Trading in the U of I Department of
Agricultural and Consumer Economics (ACE) and co-author on the
study.
Soybean futures market liquidity dropped significantly on Feb.
12 and 13, 2020, the researchers found. In contrast, corn and
wheat futures market liquidity only fell weeks later, at the
same time as other U.S. commodity and financial markets.
“Interestingly, unlike soybean futures liquidity, soybean prices
at the same time remained more closely aligned with those of
other commodities. The significant early effect was visible only
for futures and market liquidity. It was a question of looking
in the right place,” Robe says.
Futures contracts are a crucial component of commodity markets,
as a way for investors to speculate on prices and as a form of
risk insurance for major traders. U.S. agricultural producers
often trade commodities through forward sales with their local
grain elevator, establishing the parameters for the transaction
and locking in the price for a certain amount and quality of
grain, delivered at a specific date and location. That means the
grain elevator has promised a fixed price at a later time, even
though the market may move. To lay off this risk, the grain
elevator will trade on the futures market at the Chicago grain
exchange.
“Traders use the price difference between the futures now and
the futures at expiration to basically offset the changes in the
prices they are going to be getting from the cash market. So the
importance of the futures market is not only for risk
management, it is also for the price signal it is giving about
where the market is likely to be going,” Robe explains.
“Our project started when we heard from farmers in Illinois that
some elevators were unwilling to take positions when the futures
markets were closed or to take positions they would need to
carry overnight. We started looking at what they were pointing
out and found there was a huge drop in liquidity, which is the
ability for traders to trade easily without moving the price. We
decided to investigate this,” he says.
Robe and the study’s lead author Kun Peng, a doctoral student in
ACE, analyzed corn, soybean and wheat trading for the first six
months of 2020, using data from the CME Group, the major global
exchange for agricultural commodities. They compared trading and
liquidity patterns with similar data from 2016 to 2020 in a
comprehensive analysis.
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“For 2019 to 2020, we match day to day, year to year,
and we control for similar episodes and other factors that may
influence the market. We were very careful in the analysis to be
sure it's not just typical seasonality or arrival patterns. We
control for all of that and more. We find that liquidity in February
2020 was moving way more for soybean than for corn and wheat, and
the differences are not explained by volatility in general or by
seasonality. So COVID-19 really was special,” Peng explains.
Comparisons with earlier years were more complicated because of
major rule changes for exchange trading in 2015 and again in 2018.
The researchers created a set of placebo tests for 2016 and 2017 as
additional control, further confirming the strength of their
findings.
The soybean futures liquidity pullback was particularly noticeable
for calendar spread trades, which dropped 90% overnight on Feb.
12/13. Calendar spread trades lock in price differences for
different maturities, and as such they are especially useful for
grain merchandisers.
“We also find the large calendar orders from hedgers and major
players disappear at this time. That means it was harder for people
to trade, which is another signal of trouble,” Peng says.
The study demonstrates how COVID-19 affected the agricultural
market, resulting in a big cost for farmers both in terms of their
ability to protect against price risk and of the ease of trading,
the researchers note. The findings also show the importance of ag
commodity markets for financial trading in general. The study’s
insights can help provide guidance so traders can be better prepared
in the event of another shock that causes uncertainties in demand
and supply.
Robe, Peng, and their co-authors Zhepeng Hu, China Agricultural
University, and Michael Adjemian, University of Georgia, received
the NH Investments and Securities Paper Award from the Korea
Derivatives Association this summer for their paper, entitled
“Canary in the coal mine: COVID-19 and soybean futures market
liquidity,” which they presented at the 17th conference of the
Asia-Pacific Association of Derivatives.
The Department of Agricultural and Consumer Economics is in the
College of Agricultural, Consumer and Environmental Sciences,
University of Illinois.
The paper, “Canary in the coal mine: COVID-19 and soybean futures
market liquidity,” is published in SSRN [http://dx.doi.org/10.2139/ssrn.3780322].
Authors are Kun Peng, Zhepeng Hu, Michel A. Robe, and Michael K.
Adjemian.
Partial funding was provided by the United States Department of
Agriculture, Hatch-Multistate project S1072, and by the Clearing
Corporation Charitable Foundation (TCCCF).
[Sources: Kun Peng
News writer: Marianne Stein] |
