Lumber- An Ugly 2022 But Spring is on the Horizon

In March 2020, random-length lumber futures fell to $251.50 per 1,000 board feet as the global pandemic gripped markets across all asset classes. While most commodities exploded higher over the following months, lumber was a star, rising to $1,711.20 as supply chain and other issues created a shortage. In an almost perfect bullish storm for the lumber market, historically low interest rates caused a housing boom, increasing the demand for lumber when supplies were low. 

In 2022, lumber reached a lower high at $1,477.40, which was an incredible level considering that before 2018, the wood price never eclipsed $493.50. In January 2023, nearby March random-length lumber futures were sitting at the $417.70 level, with the new physical futures at $525.00. The CME is attempting the replace the random-length with the physical futures, but they have yet to achieve the critical mass necessary for success. Meanwhile, lumber is going into 2023 under pressure, but higher prices could be on the horizon in the coming months. 

Lumber has plunged and continues to make lower lows

In late November 2022, I wrote that lumber futures had gone “to sleep.” In December and early January, the wood price continued to make lower lows. 

Nearby random-length lumber futures fell 11.55% in Q4 2022 and were 67.44% lower in 2022. 

The chart illustrates the decline to $340.20 per 1,000 board feet during the first week of 2023. 

The Fed remains hawkish, pushing mortgage rates to the highest level in years

Less than one year ago, in March 2022, the short-term Fed Funds Rate sat at 0.125%. In January 2023, it was at a midpoint of 4.375%. Moreover, the Fed’s quantitative tightening program to reduce its swollen balance sheet puts upward pressure on interest rates further along the yield curve. QT at a $95 billion monthly pace is unprecedented as the U.S. central bank is battling the highest inflation since the 1980s. 

The chart shows the bearish trend in the U.S. 30-Year Treasury bond futures. In late 2022, 30-Year fixed-rate conventional mortgage rates were below 3%. In early 2023, they stand at over 7%. The monthly payment on a $400,000 mortgage has increased by over $1,330 over the past year, weighing on the demand for new and existing homes. Rising interest and mortgage rates have caused the need for lumber, a critical homebuilding ingredient, to decline.

Rate hikes will not continue at the pace established in 2022

The markets continue to digest the impact of the sharp rise in interest rates in early 2023. While most U.S. Federal Reserve economists believe rates will rise to over 5% in 2023, the trajectory of rate hikes will be lower in 2023 than in 2022. 

The Fed will continue to battle inflation with a hawkish monetary policy. Still, the recent declines in consumer and producer prices are signs that the 2022 rate hikes significantly impact inflationary pressures. Therefore, the dramatic increase in interest rates in 2022 is unlikely to repeat in 2023. 

Pent-up housing demand and infrastructure building could lift lumber- Changes in the lumber futures arena

It may take some time for the demand for new housing to return, but spring tends to be a time of the year when construction gears up and new home buyers consider moving. The upward trajectory of rents is another factor that could cause some buyers to bite the bullet and pay higher mortgage rates. Meanwhile, the migration from U.S. states with high state income taxes to states like Florida, Texas, Nevada, and others should keep new home construction going and the demand steady. In a sign of this trend, the demand for one-way U-Haul truck rentals from New York and California to Florida and Texas has caused rates to explode higher, with return trips going for a fraction of those levels. 

Three factors should support lumber prices over the coming months:

• Mortgage rates will likely stabilize over the coming months, and there is pent-up demand for new housing. With rents increasing, some renters will begin to search for new homes, with builders offering concessions after the recent price weakness. 
• The U.S. infrastructure rebuilding package will require significant lumber as wood is an essential construction ingredient.
• We are still in the heart of the winter in January 2023. The demand for lumber will likely increase over the coming months as construction projects gear up in the spring and summer.

In the November 28 Barchart article, I highlighted the $105 premium for the January physical lumber contract over the January random-length lumber contract. On January 12, the premium for the physical March contract over the random-length contract stood at $107.30 per 1,000 board feet. 

Greg Kuta, the President of Westline Capital Strategies, Inc, in Cleveland, Ohio, reached out to explain the reasons for the physical premium:

The existing legacy contract is freight on board (FOB) originating in Prince George, BC. It’s a reflection of the mill price of western spruce pine fir lumber, which legacy 110,000 board feet futures contract is derived from. The new mini lumber is FOB Chicago, so the premium of $105 represents the additional from delivering to the mill in Chicago. That’s the reason the premium in the mini. Secondly, the new contract has the ability for producers to deliver western SPF, eastern SPF, domestic and Canadian Doug Fir, and U.S. Hem Fir. Depending on the species and delivering mill, the FOB is anywhere from $80 to $105 premium to the legacy contract delivered to Chicago. Lastly, the new contract is sunset out of existence with the official and permanent expiration on May 15, 2023.

Thank you so much to Greg for the clear explanation!

Seasonality favors the upside, but prices over $1,000 are unlikely

Nearby random-length and physical lumber futures for March delivery were sitting at $417.70 and $525 per 1,000 board feet on January 12. The market could be a lot closer to the lows than the highs, as spring and the construction season are on the horizon. However, as the markets continue to digest the highest interest rates in years, the prices are unlikely to rise near the 2021 and 2022 highs. Any move above the $1,000 per 1,000 board level would be shocking in the current environment. 

The chart illustrates that the first upside target over the coming months stands at the October 2022 $550 high, which is achievable in the thinly traded random-length contract. According to the information Greg Kuta supplied, a move to challenge that level would put the new physical contract at the $630 level or higher. 

At below $425 on January 12, lumber could have upside room as illiquid markets can experience significant appreciation when they run dry of selling. 

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