URBANA, Ill. – Global financial markets collapsed in March 2020 as the COVID-19 pandemic spread across the world. But weeks earlier, soybean futures had already started providing an early warning sign of troubles ahead. Soybean futures were “the canary in the coal mine,” according to a team of agricultural economists from the University of Illinois, who studied soybean, corn, and wheat market trading in early 2020.

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.

“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.

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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).