The average traded price on the Global Dairy Trade Auction has risen a cumulative 41% at the last three GDT auctions, with whole milk powder prices back to a touch below US$2,500/tonne. A remarkable turnaround.
GDT AUCTION VS MILK PRICE FORECAST
Source: ANZ, GlobalDairyTrade, Bloomberg
On this recovery in dairy prices, there are four immediate considerations.
- GDP is a lagging indicator while commodity prices are a leading one; this reinforces the point made above.
- The terms of trade and importantly dairy prices were a key reason for the RBNZ’s shift from projecting just 50bps of total easing in June to 100bps of easing in September. The RBNZ’s terms of trade projections now look too pessimistic, and suddenly we have the prospect that monetary policy could actually be overcooking things.
- Of course we never want to get drawn into chasing dairy prices or being dictated to by them, particularly given the extent of volatility seen of late. However, the stark reality is that prices at current levels massively undermine not only the case for the RBNZ delivering four cuts in a row, but also fully reversing last year’s 100bps of tightening at all. Export prices and the terms of trade were the effective “anchor” justifying a lower OCR. Some rough and ready estimates suggest the RBNZ’s 20% peak-to-trough fall in the terms of trade is now looking more like a 15% fall (or even less!). It means that all else equal, monetary conditions don’t need to loosen as far.
- The NZD hasn’t really responded to improving dairy prices (just as it didn’t to falling ones). It’s the impact on the RBNZ’s thinking through the likes of the terms of trade that is key. The RBNZ managed to keep the NZD under the pump after the September MPS via the prospect of further easing; that’s questionable now and the currency market will start to realise it.
With regard to where dairy prices go from here, there appear two main views in the market at present.
- The market front-runs a decline in New Zealand production now (market expectations range from a 5-10% reduction in annual New Zealand supply). This leads market pricing back up over the US$3,000/tonne mark over next couple of auctions. The issue here is this likely brings more supplementary feed and competition back into the equation, and if El Nino doesn’t show up in a big way (it looks like a good proportion of the country will be fairly sodden), prices would slide again at some point, as the global demand backdrop is still fragile. The NZX futures market seems to be running with a more rapid rise as an anticipated reduction in New Zealand supply sees increased impetus from buyers. Year-to-date and current future prices are now indicating a milk price in the low-$5/kg MS could be possible. This isn’t unrealistic given the magnitude and timing of the improvement – early in the season. But it does depend on the size of further increases, and this interpretation does imply a risk another downturn at some point if New Zealand production turns out to be better than expected.
- The second view is that the price spread between New Zealand-sourced product and that of other key competitors such as Europe and the US has now closed, and many buyers loaded up on cheap product in recent months. This means buyers will be looking at other options going forward (i.e. New Zealand won’t be the cheapest source) implying price gains will slow from here. The extent of further price upside is tied to the evolution of New Zealand production, China’s buying requirements and European supply. This scenario suggests a milk price around the mid-$4/kg MS mark is likely to be more achievable.
We’re more inclined towards the latter scenario, whereas the market looks to be siding with the former. At this stage, Fonterra announced a price forecast of $4.50/kg MS on the back of a positive financial result for 2015.
Albeit with an interested eye on dairy prices, the overall economic conditions have not changed. That is, the Fed will hike eventually, but not by a lot. There will be global wobbles, with China being the key from here; we’re still cautious. The New Zealand economy is sombre but not on its knees and we’ll take a glass half full interpretation of the stabilisation that is now occurring. Finally, we can not agree with the case for the RBNZ delivering four cuts in a row.