Aus­tralia caught in game of cur­rency roulette

Dairy News Australia - - MARKETS - STEVE SPENCER • Steve Spencer is a di­rec­tor of www.fre­sha­genda.com.au

WHILE THE world mar­ket for dairy prod­ucts is in much bet­ter shape go­ing into the 2017–18 south­ern pro­duc­tion sea­son, there are still a few risks that may weaken milk prices for South­ern Aus­tralian dairy farm­ers. One of those is the value of the Aus­tralian dol­lar. Our own es­ti­mates of the 2017–18 far­m­gate price are based on an im­por­tant as­sump­tion that the lo­cal cur­rency will av­er­age US$0.76 for the sea­son. A few short weeks ago that looked a pretty safe num­ber, but re­cently the A$ has soared, back past US$0.80 for a short while, set­tling back be­low that at the time of writ­ing. The ex­change rate, as farm­ers never tire of hear­ing, is fairly crit­i­cal in the scheme of things. A 1¢ shift in the A$ against the US, with all else be­ing equal in the­ory, af­fects the value of milk at far­m­gate by 10–12¢/litre. So if there is a per­ma­nent 4¢ hike in the dol­lar, and noth­ing else changes, that could punch a big hole in full year ex­pec­ta­tions, po­ten­tially mean­ing open­ing prices re­main as clos­ing prices. Of course, that de­pends on in­di­vid­ual com­pany ex­po­sures to cur­rency in prod­uct pricing and it de­pends what hap­pens to other cur­ren­cies. I’ll come back to that. Why has our dol­lar surged? Well our busi­ness is not skilled in the anal­y­sis and fore­cast­ing of cur­rency move­ments. But we watch de­vel­op­ments and un­der­stand the strong in­flu­ences, so we can un­der­stand the up­side and down­side risks that lie ahead. So this is my un­skilled, layper­son view of what seems to be out there driv­ing the dol­lar.

A 1¢ shift in the A$ against the US, with all else be­ing equal in the­ory, af­fects the value of milk at farm gate by 10–12¢/litre.

Lately much of the strength in the Aus­tralian dol­lar seems to be due to weak­ness in the US cur­rency, which has also fallen against the Euro and even the Ja­panese Yen. In 2017, af­ter the elec­tion of Don­ald Trump as the self-pro­claimed re­formist, this is not how the script was writ­ten. Trump was go­ing to take the shack­les off the US econ­omy, spend big on in­fra­struc­ture and fix the big bad bud­get deficits. The US dol­lar was sup­posed to strengthen. It wasn’t al­ways clear how this was go­ing to help boost US trade. It’s done the re­verse. The Trump ad­min­is­tra­tion chaos ap­pears to be wors­en­ing, with an un­hinged Pres­i­dent more be­sot­ted with me­dia opin­ion, Twit­ter likes, his hair, and un­do­ing any- thing Obama did, rather than mak­ing sound de­ci­sions and lis­ten­ing to ex­pe­ri­ence, en­sur­ing few of his re­form agenda items get up. The fi­nan­cial mar­kets have lost faith in the abil­ity to re­struc­ture the US bal­ance sheet and fi­nance big spend­ing plans. As a re­sult, the US dol­lar has slid more than 10 per cent against the Euro since early March. Europe’s cur­rency is stag­ing its own re­vival in the process with a brighter out­look for the big economies in the bloc, and more op­ti­mism about lead­er­ship with the out­come of Dutch and French elec­tions, where right-wing iso­la­tion­ists were re­jected by the peo­ple. When we come back to our dol­lar, there’s al­ways talk of the in­flu­ence of “relative in­ter­est rates” — the dif­fer­ence be­tween the cost of money in Aus­tralia ver­sus the US. With money mar­kets fig­ur­ing there is a smaller chance of in­ter­est rate rises in the US, and ongo- ing heat in the prop­erty mar­ket in Aus­tralia, this helps talk up the value of the lo­cal cur­rency. More money would there­fore flood into the A$ to get the ben­e­fit of higher in­ter­est rates com­pared to the US and other low-in­ter­est economies. This doesn’t al­ways hold — the other big vari­ables that af­fect the value of the A$ are com­mod­ity prices for met­als and, in par­tic­u­lar, iron ore, due to the im­por­tance of those com­modi­ties to ex­port earn­ings and Aus­tralia’s trade bal­ance ….even though the min­ing boom is over, right? The chart on this page shows the close track­ing of the value of the A$ and iron ore prices in the past 4 years. There is clearly some­thing in that. We can’t look at US v Aus­tralia cur­rency rates in iso­la­tion. In some dairy com­modi­ties, such as ched­dar cheese, but­ter and skim milk pow­der, where the vol­ume of EU ex­ports is sig­nif­i­cant, Euro­pean whole­sale prices (ex­pressed in Eu­ros) strongly in­flu­ence world mar­ket prices against which other ex­porters com­pete. With a stronger Euro, the US$ value of prices sought by Euro­pean ex­porters will rise, driv­ing higher prices in the trade — and hence a ris­ing A$ may off­set only some of the gloss from those gains. That won’t al­ways work — it de­pends if another big ex­porter such as the US it­self or New Zealand gets ag­gres­sive and seeks to buy greater mar­ket share. Where is the dol­lar go­ing? Most cur­rency ex­perts sit­ting in big banks and fi­nance houses tip the Aussie to fall against the US in the com­ing year. Some see it fall­ing hard into the low 70 cents ter­ri­tory, and stay­ing there. If that hap­pens, it could be a boon for Aus­tralian dairy farm­ers in the next cou­ple of sea­sons, sorely needed to im­prove farm cash flows … and con­fi­dence in this in­dus­try.

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