Macroeconomic and Sector-level Performance
U.S. Real GDP Growth ? Let?s begin with a quick overview of the general economy. After impressive growth of 5% in the first quarter of 2002, growth in the second quarter was much more modest, coming in at 1.1%. While much better than what was observed at this time last year, the slower growth relative to the first quarter reflects decelerations in inventory investment and personal consumer expenditures. A recent poll of economists expects growth for the year to range between 2.0 and 3.0 percent.
CBO Federal Budget Surplus ? In late August, CBO released its latest outlook for the federal budget. In general, the surpluses projected in the March baseline have disappeared, and they are now calling for deficits through FY2005. For FY2002, the deficit is expected to be approximately $150 billion. Lower revenues and increased spending share equal blame in the more pessimistic outlook. (The ag supply & demand numbers included in those estimates did not reflect the recent increase in grain and oilseed prices. CBO has revised their crop projections to reflect the higher prices and now call for $5.6 billion less spending in FY03 than originally thought.)
U.S. Net Farm Income ? The most recent estimates for the ag economy have also become more gloomy. USDA?s latest numbers put 2002 net farm income at $35.2 billion, down from $45.7 billion in 2001. The vast majority of the decline in net farm income is due to lower livestock receipts. While crop receipts are expected to increase, much of the increase will be offset by lower government payments. Government payments for the current calendar year are projected to reach $16.2 billion, a decline from the past three years.
Prices Received Index ? Over the last several weeks, the grain and livestock markets have been headed in opposite directions. The crop price index increased by 5 percent from July to August led by grain price increases of 8-10 percent. The livestock price index has continued to decline and now stands at 22 percent below year-ago levels.
Prospects for Cotton Production
U.S. Cotton Plantings ? The August Crop Production made some minor revisions to U.S. cotton acreage, relative to the June Acreage report. U.S. cotton acreage is now put at just under 14.4 million acres. Upland plantings fall from 15.5 million to 14.12 million, while ELS goes from 270 thousand acres down to 265 thousand acres. Declines are seen in all regions of the US with the Mid-South and West accounting for the largest declines in percentage terms.
U.S. Cotton Production ? According to this morning?s report, the U.S. crop is estimated to be 18.1 million bales, down 300 thousand from the August estimate. The drop is primarily due to harvested acreage and not yields. Lower acreage in AR, LA, SC & TX. There were yield declines in GA, NC & VA. National average yield remained unchanged at 675 pounds per acre.
World Cotton Production ? USDA now estimates that world production is 88.6 million bales, about 9.5 million bales below the 2001 estimate. Outside the U.S., the most notable change was a 400 thousand-bale decline in Australia (2.6 down to 2.2). Estimates by ICAC and Cotton Outlook range between 88 and 89 million bales.
Outlook for Mill Use
First, let?s focus on a few of the drivers of domestic mill use.
Real Exchange Rate Indices ? The strength of the U.S. dollar is a major factor in the competitiveness of U.S. exports and also in the surge of textile and apparel imports into the U.S. The Federal Reserve calculates exchange rate indices relative to major currencies and other important trade partners. The Euro, the Yen, and the Canadian dollar dominate the major-currency index. China, Taiwan, Korea and Hong Kong carry the greatest weights in the calculation of OITP. Between 1997 and early 2002, both showed significant strengthening of the dollar. Since the beginning of 2002, the dollar has weakened against the major currencies, i.e. Euro, but has not shown the same weakness against currencies included in the OITP index.
Net Imports of Cotton Textiles ? Now, shifting our attention to textile imports, net imports of cotton totaled 11.2 million bale-equivalents in calendar 2001. As shown in the chart, monthly imports range between 800 thousand and 1.1 million bale-equivalents. This averages 140 thousand-bales/month more than the 1998-2000 period. Data available through May 2002 suggest that imports are up again, averaging 70 thousand/month more than a year ago.
Net Domestic Consumption of Cotton ? After years of strong growth, net domestic consumption of cotton fell in 2001. As you?ll see in the chart, it was particularly poor in the second half of last year, consistently falling below the levels observed in 1998-2000. We certainly have to look at the general economy as one of the reasons for the decline because we also saw declines in man-made fiber consumption as well. Year-to-date numbers are very similar to past years. The key will be whether or not we can improve in the second half of the year. Longer term, can we continue to expand retail consumption or has the market reached a level of maturity?
Cotton Mill Use ? More imports and less domestic retail consumption led to a significant decline in U.S. mill use. During 2001, monthly mill use averaged 200 thousand fewer bales than what was observed during the 1998-2000 period. The early months of this year came in below year-ago levels. Data for the most recent months do provide some optimism as the June number and the preliminary July estimate were above the comparable months in 2001.
U.S. Cotton Mill Use ? Looking at the marketing-year numbers, today?s report made almost no change in mill use for 2001/02. It remains at 7.7 million bales. Modest improvement expected for 2002, with 7.9 million bales expected.
World Cotton Mill Use ? Further growth in world mill use is expected for the current marketing year. USDA is probably the most optimistic with consumption of 96.7 million bales. Cotton Outlook and ICAC would 1.0-1.5 million bales below that number.
U.S. Export Potential
The reliance of the U.S. cotton market on exports has increased dramatically over the past two years. We have seen a complete reversal in the contributions of exports and domestic mill use to total off-take. For 2001/02, exports contributed about 60% of total use. As we look at the potential for U.S. exports, a couple of questions to keep in mind ? Is there a market for that much cotton? and Can the U.S. remain competitive enough to capture those markets?
Step 2 Payment Rate ? The new farm bill maintained Step 2 payments and also eliminated the 1.25-cent threshold, which became effective in the calculations beginning in mid-May. Without the elimination of the 1.25 threshold, we would have already seen Step 2 payments disappear.
Foreign Mill Consumption less Production ? In recent years, foreign consumption usually exceeds foreign production by 4-8 million bales. In 2002, USDA?s numbers would suggest that the deficit nears 18 million bales. Longer term, the deficit will be key if the US is to maintain 10-11 million bales of exports.
Chinese Net Trade ? China continues to be a wildcard. Current estimates put China?s net trade position for the coming marketing year at just over 1 million bales. No changes were made in today?s report.
Stocks, Price, Returns
Cotton Ending Stocks ? This chart shows ending stocks broken into three categories: China, the U.S., and all other countries. Since 1998, we have seen estimates of Chinese stocks decline, but stocks outside of China have continued to increase. At the close of the ?01 marketing year, USDA says that we went above 25 million outside of the US and China and U.S. stocks are all the way up to 7.6 million bales. Today?s report made no change in U.S. stocks and there continues to be the discrepancy with Commerce numbers. Given the smaller crop for 2002 and the increased mill use, stocks in all three categories are expected to decline by the end of the current marketing year. Again, the sharpest declines are in China. For the U.S., USDA?s latest numbers for the current marketing year put stocks at 6.7 million bales. It?s a move in the right direction, but still a lot of stocks on hand.
Cotton Prices ? Between mid-May and early July, cotton prices gained about 10 cents/pound and have remained in that range since. Despite the increase, prices continue to remain below historical averages. It?s also interesting to note the change in the relationships between the prices. Since early in 2001, there?s been a shift in the relationship between the US NE quote and the "A" Index. We have seen the spread fall from 5 cents down to a penny or less in recent weeks. Subsequently, spot prices have also weakened relative to the "A". Reasons for the shift: large US stocks and the need to ship 60% of the US crop onto world markets. One implication: as long as we have stocks at current levels, the weakness of US spot prices relative the "A" suggests smaller equities than in the past.
December Cotton Futures ? The rally in early June pushed cotton futures above year-ago levels. Dec has continued to trade between 45 and 50 cents for the last several weeks. Old crop stocks and harvest-time pressure are reasons to feel there?s more downside pressure in the near-term than upside potential. Longer term, a tighter S&D should be a boost. Another area to watch is the grain market. We?ve seen significant increases in recent weeks. If those hold until the spring, to what extent will other crops bid acres away from cotton?
Cotton Prices and Returns ? Current markets would put the US season-average farm price at 39-43 cents per pound. Given normal relationships with the A-Index and AWP, marketing loan gains would range between 13-17 cents. At this point, all likely scenarios suggest CCPs will be at the maximum level of 13.73 cents per pound.
Upland Cotton Gross Revenue ? Based on U.S. average yields and the prices discussed earlier, total gross revenue should be modestly higher than the 1998-2000 levels. The combination of market returns and marketing loans should fall below last year given lower yields, but direct and counter-cyclical payments under the new farm bill will contribute about $100 per acre to gross revenues.
Key issues to watch as we move into the fall and the remainder of the marketing year:
- Harvest progress
- Monthly mill use numbers
- Chinese imports
- Grain & oilseed price movements
Mr. Chairman, that concludes my remarks on the economic outlook.
