2016/17 nearly over

The 2016/17 season is coming to a close and although there have been a  few surprises (March production data), the emphasis is now really on 2017/18.  It is worth noting that the year has been better than expected from a revenue and profitability perspective, notwithstanding the climatic challenges that farmers have been through. At the start of the season a $6+ milk price and a 40 cent dividend was something we would have all accepted without too much thought!

I thought that it would be worth reviewing global milk production  and some of the other key factor impacting farmer returns.

Production:

The charts below are courtesy of the team at Rice Dairies. In essence they highlight the key trends (green columns 2017):

  • Continued growth in US production
  • A pullback in European production (YoY) but output still well above pre-deregulation levels
  • Flat to lower NZ output now driven more by weather and stock numbers (on farm productivity) than conversions (new capacity)
  • Lower output in Australia driven by poor industry confidence and lower profitability levels

It would seem that these trends will remain in place through the balance of the calendar year, if not for the full next season. It should be noted, however, that the European Commission is forecasting a 0.6% rise in EU production this year.

Commodity price, the currency and interest rates:

I regularly insert the chart below but to remind you, the “pink line” is WMP prices (LHS) and the “yellow bars”, represents the kiwi dollar. The WMP price has recently recovered but this has been accompanied by a weakening in the NZD which is actually challenging a significant support level at US68.5 cents, although we saw a bounce off this level laast night. This divergence is favourable for NZ farm gate receipts so the questions are why we are seeing this divergence and whether it is sustainable?

A similar divergence has occurred in the Australian dollar with commodity prices rising markedly this year (driven largely by coal and iron ore) but interest rate differentials suggest a weaker AUD (and kiwi).

Hence, the real story so far this year probably lies more in interest rates. The RBNZ and RBA have been waiting for some years for a turnaround in US monetary policy to see a swing in speculative and “carry” flows back to the USD. This is now beginning to occur with the US now into a tightening cycle while monetary policy (despite housing) remains “on hold” in both New Zealand and Australia.

In summary, the NZD and AUD are driven by a combination of commodity prices and interest rate differentials but for the present the interest rate argument appears to have the upper hand.

This next chart (courtesy of DB) shows expectations for the Fed Funds rate in the US. The Fed has now raised rates 3 times since Dec 2015 from a 0% - 0.25% band (effectively 0) to now 0.75-1.00%. However, importantly, the chart below shows that both the Fed and DB are expecting the Fed Funds rate to rise by a further 2% (to 3%) over the next 24 months. The “market” is currently forecasting a smaller rise to only 1.75% but to the extent that they are too “dovish”, US rate rises (potentially once a quarter) will continue to keep some downward pressure on the NZD.

So, in summary, a steadier demand-supply picture globally, a more competitively priced NZD and an interest rate outlook that remains relatively stable (although we have seen the lows) suggests a better outlook for farmers than we were facing this time 12 months ago.

Australian fall out continues:

In good news for Fonterra last Friday, the ACCC (Australian Competition and Consumer Commission) announced it was taking no further action against Fonterra over their action in lowering prices paid to farmers in Australia one week after Murray Goulburn lowered payments last season. However, the ACCC is seeking a declaration that Murray Goulburn knowingly overstated forecasts. The ACCC will not seek pecuniary damages against MG as it believes that will further impact farmers. However, it is seeking “seven year disqualification orders and pecuniary penalties” against both the former CEO and CFO of Murray Goulburn.

If nothing else, this should lead to a more transparent market in Australia and work to prevent a repeat of the challenges of the 2015/16 season. “Talk it up and hope” is not a strategy!!

Global Trade – the US and Canada:

The atmospherics around global trade is interesting and fluid.

After withdrawing from TPP, the US Administration flagged a withdrawal from, or renegotiation of, NAFTA and then backed away from the more extreme aspects of that threat, although negotiations will be ongoing for some time. President Trump has also backed away from previous accusations of China as a “currency manipulator” (perhaps seeking support from them on North Korea) reducing trade threats on that front.

While the failure of TPP was not a good outcome for NZ dairy, the US industry had severely limited any benefit to NZ dairy under TPP. There is unlikely to be a quick bilateral fix on US market access.

One good piece of news, from a medium term perspective, is increasing US (and Canadian) focus on the Canadian market structure, partly as a result of direct criticism of the structure by President Trump who said it is “harming US producers in New York and Wisconsin”. Like all heavily protected and inefficient markets, there seems to be a heightened dialogue within Canada around the costs and benefits. There is no current farmer or political support for reform but with the US now exporting 15% - 20% of their milk, they will be more effective at breaking down this barrier to efficient production and export than NZ was during TPP. In fact, the US was happy to hide behind Canada during that process.

The bottom line is that while Donald Trump has not been good for global trade and was quick out of the blocks on TPP, some more moderate and experienced voices appear to be exerting somewhat greater influence on trade issues and at least slowing down some of the more radical proposals.

Generally, the Trump Administration is well behind where it anticipated it would be on domestic issues after the first 100 days (Obamacare, infrastructure, tax etc) albeit that he has made more of an impact than was expected on global geopolitics. His unexpected focus on global political issues may force him to have a more conciliatory approach to traditional allies.

An early test of this will be his first face to face with the Australian Prime Minister In NY this week (dinner on the USS Intrepid to commemorate the 75th anniversary of the battle of the Coral Sea). The only direct dealings between the 2 to date (that have been reported) was a phone call soon after the President’s inauguration which went so well that it was reported that President Trump hung up on Prime Minister Turnbull. When asked to comment, the White House spokesman (Sean Spicer) said that the President had no issues with “Mr Trumble!” Informed sources expect a “love fest” this week. It will be a good week to be a kiwi!!

Milk Production:

You will all have observed the March production numbers (+9.9% over March 2016 month) and the NZ season to date is now only -1.3% YTD, compared with the -5%-7% numbers that were being discussed earlier in the season. That, together with the improved prices received to date will be of considerable benefit to farm incomes.  

The last few weeks have been a bit rough weather wise but April data will be more interesting than usual!! Notwithstanding this data, Fonterra, at this stage, hasn’t increased forecast volumes available on GDT.

This week’s auction:

The volumes being auctioned are in line with what was previously announced but WMP volumes are at their seasonal low and down 17% on the last auction while SMP volumes are up 15% on the previous auction.

Expectations for this week’s auction are for a result pretty much in line with the last auction. The May WMP price suggests a small rise in the auction tonight but there is contango (ie. lower prices) in the curve through to June. Particular interest in certain dates or products could impact the outcome and any positive outcome would be good but it feels like it could be +/- 3%.

The milk futures contracts have seen some activity. 2016/17 is little changed (+2c) at $6.05/kgMS since the last auction but the 2017/18 contact is +12c at $6.25/kgMS. “Spot” analysis suggests (currently) a 2017/18 price of $6.35-$6.65/kgMS (depending upon assumptions and daily rates) but there does appear to be farmer hedging interest above $6.25/kgMS.