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GDT #214 - Trump Trade or Growth?



The Macro picture:

As regular readers of my column know, I am a subscriber to the DB view that says that it is in the US interests to be forging an FTA with China not creating a trade war and you can't take too much notice of the "sound and fury" from the Trump Administration as their methods are unconventional and therefore unpredictable (witness the love fest in Singapore last week!)

We saw another round of threats and some more detail on the looming 6 July tariff impositions last week and we saw an immediate response from China. Of interest to this column is that amongst the "longer list" of US products to now attract an increased tariff in China (the list has grown from 109 products originally announced to 659 products but hasn't changed in value significantly) are a lot more food and agricultural products including dairy exports from the US. Key products include whey, SMP, cheese, WMP and butter. Meat, poultry, seafood, fruit and staples are also now listed.

Markets, over the weekend, did not respond well to this prospect. In particular, soft commodities and metals weakened and bond markets rallied. Both these moves would suggest growth fears emanating from a trade war.

I continue to hold some optimism that rationale minds will prevail (although watching Larry Kudlow and Paul Navarro go after Justin Trudeau last week again makes you wonder who the "rational minds" may be?) The core of the "rational" argument that a trade war is not in US interests [notwithstanding there are legitimate issues on technology transfer and IP issues] is best summarised in the (updated) DB chart below.

Figure1: US firms may have sold more to China than Chinese firms to the US in 2017

DB's Chief Economist in China has estimated that "round 1" of this trade war will only impact China growth by -0.1%. However, he notes that were there to be a second round of tariffs imposed (impacting circa $100b of US imports) this could impact growth by -0.3%. At that point (or at the point this escalation seems likely), he expects that China would have a domestic policy response that could extend to a range of fiscal and monetary policy measures. As we saw in the GFC, the Chinese don't leave much to chance and this domestic stimulus could potentially more than offset the impact of the trade issues.

I concede that this is one for "the glass half full team" but I am going with it!!

Central Banks and Monetary Policy:

Last week was a very busy week with the Federal Reserve, the ECB and BoJ all holding meetings.

The first cab off the rank was the Federal Reserve and once again the "glass half empty" team was in control with it seen by many as being "slightly hawkish". This was best seen in the reaction of the USD. The trigger for this view was one Fed Governor changing his prediction from 3 rate rises to 4 rate rises this year. This changed the "dot curve" shown below.

To me, the more interesting aspect of the dot chart is that the "peak" (or terminal rate) for this cycle is now seen as a modest 3.375% compared with 2% today. Secondly, the "long term" (or neutral) rate now appears to have dropped fractionally below 3% in the view of the Federal Governors. Net on net this looks to me to be positive for risk assets, although I concede, whether this is the case, or not, is somewhat dependent on the "causes" of rates peaking.

The Fed's Dot Plot

The ECB was second cab off the rank and although it announced further tapering of its quantitative easing (ie. a lower level of net bond purchases and therefore net liquidity injections) it surprised the market by suggesting that no rate rise was likely before the middle of next summer (call it July 2019). This wasn't wildly outside market expectations and pricing.....they were just surprised that the ECB would go "short optionality" to the extent of articulating a view more than 12 months out!

So with European real yields at record low levels (ie. real rates are negative so monetary policy remains highly accommodative) as shown below, the ECB has signalled that this situation may persist for more another 12 months.

Figure 16: GDP weighted real yields remain close to historic lows

Secondly, as per the above analysis of the US long term "neutral rate" being below 3%, the market in Europe is currently pricing the overnight rate in 5 years from now at roughly 75 bps! [the chart headline from DB below notes that this is low relative to their expectations but this is where the market is pricing it.]

Figure 4: The terminal rate is low reative to our neutral rate estimates

So in summary, the Federal Reserve, in my view, is not terribly hawkish and the market is broadly now pricing within +/- 25bps of the Fed. Secondly, the ECB remains dovish and hence the immediately "bullish" response of the USD as shown below.


So what does this mean for us as we head into the new season and financial year.

In summary, NZ rates rightly (in my view) continue to trade in the same range as they have since the middle of last year and there seems little impetus for a major move with the RBNZ and RBA on hold and the US market now pricing broadly in line with the Federal Reserve.


Secondly, as the USD has strengthened in recent days, bearish sentiment on the kiwi has grown. However, while I expect that we will trade to the bottom of the range (as shown on the chart below), I am not convinced that there is sufficient momentum for a big move significantly below US68 cents.

Weekly NZD

One factor that could drive the kiwi lower(arguing against myself), however, is the fact that reported IMM positions suggest that the market is not really short kiwi on this move. If you look at the chart below you will notice that the market was significantly short past the lows in Q2 last year and earlier this year.

Figure 10: Speculative NZD positions

That's probably sufficient on "macro". In summarise;
- The Trump trade tweets (TTT) are close to turning into tariffs (TTT2T) but at this stage are impacting sentiment more than growth;
- Beware round 2 of the "TTT2T" but also beware the China domestic policy response;
- The Fed Reserve view does not look as hawkish to me as the commodity and debt markets are suggesting and the ECB remains dovish;
- Kiwi and Aussie rates don't look under much pressure;
- The NZD and AUD are under pressure and the lack of large positions and USD sentiment could drive them to or through technical levels but I can't get too bearish for the reasons articulated above.
- One final comment not referred to above is that there is an OPEC meeting scheduled for Friday – Saturday in Vienna. Those of you who follow me know that I like to watch these meetings. The oil market is expecting some increased production and that is reflected in the weaker oil price in recent weeks although sentiment is volatile.

NZ Corporate News:

I am sure some of you are tired of me showing this chart and I am tired of looking at it too. However, there has been no recovery in sentiment on FSF over the last 2 weeks and although it has held above $5, it is only just managing to do so.

Weekly FSF.NZ

In relation to FSF, one announcement that seems to have attracted less comment than I thought it might, is the ComCom paper published last Thursday entitled "Review of Fonterra's 2017/18 base milk price calculation". In essence it invites submissions on:

"our emerging view on whether or not the asset beta of 0.38 proposed by Fonterra for setting the 2017/18 base milk price is practicably feasible for an efficient processor".

The implication is that this should be revised up and would result in a change in the calculation of the FGMP versus Fonterra earnings. This process has a way to play out and is probably minor in terms of the 2018/19 FGMP (relative to the changes that could be induced by commodity prices) but it will ultimately be very important for FSF units and also for the competitive pressure that Fonterra currently applies to other dairy companies via its FGMP calculation.

I would also note that Danone (which has a 25% share in Yashili International) appears to have stepped up its interest in Yashili's NZ Dairy Company by acquiring a 49.9% stake. With the balance held by YI, that would appear to give Danone effective control over the NZ operation.

On other areas of competition, we are getting close to a sale of the (now) Saputo owned Koroit plant. Depending on the buyer (Bega is probably the logical buyer), the competitive landscape in SW Victoria could change. Bear in mind that the ACCC ruling (mandating the sale by Saputo as part of the approval of the MG acquisition) was specifically aimed at increasing competition in the region and this plant is operating at <50% of "plated" capacity.

GDT #214:

As shown below, GDT #213 came in slightly below futures pricing leading into the auction. Current WMP pricing is a touch weaker than that auction result. With SMP and AMF trading weaker in July than at the time of the last auction, another slightly weak result can be expected. However, with a weaker kiwi this expectation is currently not resulting in a weaker MKP futures price with 2018/19 still trading at $6.85/kgMS.

WMP results GDT #213 versus future pricing

The way to start the day (and just to make it worth it for those of you who got this far!

Just to finish on a lighter note for all you farmers who think that milking cows early in the morning is tough!

Two of my good friends (of 30 years standing) – Tony Rich and Chris Selby - surf at Bondi Beach at day break most mornings all year round. In fact, they regularly remind me that I owe them a surf and breakfast.

However, last Saturday morning Chris decided to play at Crocodile Dundee (call that a fish!) when while body surfing he saw a large shadow beneath him! At what point he determined that it was a "dead" 2.5m Mako shark we have yet to determine, but admirably he hung around to find out and then he decided that it was better out of the water than in (as it would attract other sharks) and so he manhandled the 200kg shark to the beach.

It makes for great photos (thanks to a surfer with a GoPro) and for those of you who doubt the veracity of these photos, I attach the following link from Australia's Channel 9 TV. It's not "fake news".

As an aside, before you forward to your mates to show how brave (or mad) Australians are, while Chris is an Australian citizen and has been here for over 30 years, he hails from Wyoming so the team at Rice Dairies can pay particular attention – this could be you guys if you immigrated (lean, mean and just ever so slightly mad!)

JT Macfarlane
Colmac Group Pty Ltd


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