Comment Text:
Innovative Livestock Services strongly supports the linking of expanded limits between the Live Cattle and Feeder Cattle Contracts and offers no objection to the other changes proposed by CME Group.
These two commodities have a natural economic relationship. The deferred Live Cattle Contract is the best representation of demand for the Feeder Cattle Contract and the Feeder Cattle Contract is the best representation of supply for the deferred Live Cattle Contract. A change in the price of either contract creates an immediate effect on the value of the other contract.
The magnitude of a price change to return to equilibrium after a price change in the corresponding contract is determined by the relative weights of feeder cattle and fed cattle. Given current production practices, fed cattle are commonly marketed at weights of 1.7-1.9 times the weights in the Feeder Cattle Index. CME’s deliverable steer weights reflect this ratio; the 1600 lb. maximum deliverable weight is 1.78 times the 899 lb. Feeder Index upper bound.
Thus a price change in Live Cattle would create a demand shift for Feeder Cattle which, ceteris paribus, would cause a price change in Feeder Cattle 1.7 to 1.9 times the initial change in Live Cattle price. The same is true of a price change originating in the Feeder Cattle Contract which would indicate a supply shift for Live Cattle which would cause a price change of .52 to .58 (1/1.7-1/1.9) times the initial change in Feeder Cattle price, ceteris paribus.
As demonstrated above, the current 1.5:1 ratio ($4.5:$3) of daily price limits between the Feeder Cattle and Live Cattle Contracts is currently too small to allow immediate reflection of the economic impact caused by a limit move in Live Cattle price in the Feeder Cattle Contract. The potential for expanded limits in Live Cattle without expanded limits in Feeder Cattle allows for this ratio to some days only be 1:1 ($4.5:$4.5). This scenario has occurred multiple times in 2020.
When the ratio of price limits for Feeder Cattle and Live Cattle is too low, large changes in Live Cattle prices not only cause limit moves in Feeder Cattle, but will also cause a large carryover effect the following day. This creates a cascading effect where business is unable to be transacted for multiple days.
While we continue to encourage the CME to set the ratio of Feeder Cattle to Live Cattle daily price limits closer to its economically appropriate range, we are extremely supportive of the current proposal’s linking expanded limits to allow the markets to better function during extreme price moves.
