Pork production is a low-margin business. Outside forces — interest rates, inflation, employment rate and consumer incomes, health of the general economy, fiscal policy and monetary policy all influence pork producer profits. Profit expectations drive expansion plans. Outside forces create uncertainty in profit projections.

Pork producers appear to be factoring in those outside uncertainties and tapping the brakes. The March 1 inventory of all hogs and pigs on U.S. farms is 7.3% smaller than at its last peak of 78.58 million head on Sept. 1, 2019, according to USDA’s latest Quarterly Hogs and Pigs report.

Inflation may push pork and hog prices higher. But inflation and higher interest rates will boost production costs. Even the most highly productive pork producers could end up handling more dollars — but pocketing fewer of them.

Some analysts say easy money policy, federal stimulus spending in response to COVID-19, and rising consumer spending combined with consumers buying now because “it” will cost more later all fuel inflation. Whatever the causes, inflation remains public economic enemy No. 1.

February 2023’s inflation rate, as measured by the year-over-year change in the consumer price index, was 6%. It slowed a tad from January’s 6.4%. While down from the June 2022 peak of 9.1%, inflation is still well above the Federal Reserve’s 2% target rate.

Days of easy credit are over

The Fed has been hiking interest rates to ease inflation. The notion is that higher interest rates throttle buying power, which reduces upward pressure on the general price level. The Fed indicates that it is not finished hiking interest rates.

The Seventh Federal Reserve District is made up of Iowa and most of Illinois, Indiana, Michigan and Wisconsin. A survey of the district’s banks showed nominal interest rates on new farm operating loans averaged 7.5% as of Dec. 31, 2022. Farm real estate loans averaged 6.80%. These are the highest rates since the fourth quarter of 2007.

In March, the Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri released its latest 10-year baseline update for U.S. agricultural markets. FAPRI forecasts suggest the prime rate will remain above the pre-pandemic level through 2032. The prime rate is generally the lowest rate of interest charged by a bank, with other variable-rate loans (e.g., credit cards, lines of credit, variable-rate mortgages, home equity loans and home equity lines of credit) calculated as a certain amount over prime.

Dampening expansion plans

Rising interest rates make investing in land, buildings, machinery, equipment and inventory more expensive. As producers evaluate whether to invest, how much to invest and when to invest to expand production, they analyze the expected rate of return on the investment and the interest rate.

If pork producers think the rate of return on a project will be higher than the interest rate, they will carry out the project. Therefore, producers have more incentives to invest when interest rates are low. In contrast, higher interest rates boost investment costs, which deter investment. Less investment in production may tighten supply, therefore lifting prices and potentially hiking producer profits. But that takes time.

Investing requires capital. Producers can borrow to invest or use owner’s equity. Capital cost is either the cash interest paid if the business has debt, or the interest that would have been earned on equity had the money been invested elsewhere.

Ag attitude toward growth

The Ag Economy Barometer is a collaboration between Purdue University’s Center for Commercial Agriculture and the CME Group to provide monthly nationwide measures of the health of the U.S. agricultural economy. Each month, agricultural producers are surveyed to get a feel for monthly economic sentiment.

Seventy-two percent of producers in the February 2023 Ag Economy Barometer survey said it is a “bad time” to make large investments in their farming operation. Just 15% reported it is a “good time” to make such investments.

Of the respondents who said it is a “bad time” to make large investments, 45% said it was because of the rise in prices for farm machinery and new construction, while 27% of respondents chose “rising interest rates” as a primary reason for it being a poor time for making large investments. The percentage of respondents focused on rising interest rates as a key reason has doubled since July 2022, when this question was first included in the Ag Economy Barometer survey.

The February 2023 Ag Economy Barometer survey included a question focusing on farm growth. It asked respondents what annual growth rate they expect for their farm over the next five years. Of survey respondents:

Hog cycle could stretch

Hog production and price cycles have existed ever since hogs became a major enterprise in U.S. agriculture. Hog cycles are recurring changes in production and/or prices. Cycles are typically several years in length. A complete cycle includes successive years of increase and decrease in either hog production or prices extending from one peak to the next peak (or one trough to the next trough). This is in contrast to seasonal patterns, which are recurring production or price changes that take place within a year.

Hog production cycles exist because hog producers respond to changing economic conditions in the hog business. When hogs have been profitable for a while, producers begin to expand production to take advantage of the expected profit opportunity. Expansion typically continues until larger supplies cause prices to drop to unprofitable levels for most producers.

However, hog prices and profits are not the only hog production cycle drivers. Financial position matters. Sometimes producers see profits ahead and would like to expand, but they cannot until they shore up finances after a series of losses.

Changes in production costs also affect profitability and can contribute to cyclical production trends. Recent sharply higher interest rates boost the cash needed to service debt, which may be deterring current expansion plans. Other outside forces heighten uncertainty, which may also dampen enthusiasm for expansion. Even after producers choose to boost the breeding herd and/or add facilities, biology dictates time needed to get more hogs to market.

Optimism for expansion remains scarce

The inventory of all hogs and pigs on U.S. farms on March 1, 2023, was 72.86 million head. This was up 0.2% from March 1, 2022, but down 2.1% from Dec. 1, 2022. Other than March 1, 2022, this is the smallest swine herd since June 1, 2018.

U.S. hog producers intend to have 2.93 million sows farrow during the March-May 2023 quarter. This would be down 1.2% from the actual March-May 2022 sows farrowing and down 3.4% from the same period in 2021. If producers do not change intentions, this would be the smallest March-May sows farrowing since 2015. Intended sows farrowing for June-August 2023, at 2.973 million sows, would be down 2.9% from the actual sows farrowing during the same period one year earlier, and down 2.5% from the same period two years earlier. This would be the smallest June-August sows farrowing since 2014. These are rather pessimistic farrowing intentions.

Pork production is a low-margin business. Rising interest rates boost the cash producers need to service debt. Looking back, historically low interest rates from 2012 through 2021 helped spur investment and pork industry expansion. Low financing costs can sometimes cloud the determination as to whether good performance and changes in hog inventories resulted from strong operations or lower debt costs. The next several years will help answer that question.

Schulz is an Extension ag economist with Iowa State University.