Dairy production in Aussie and Kiwi to reduce, rise in Europe and U.S. - Euro and Dollar stronger against Antipodeans on trade terms

Dairy prices took another step lower in last night's Global Dairy Trade auction. The headline index slid 2.8%, while whole milk powder prices were down 3.7%. Although lower prices were well signalled by futures markets, last night's confirmation will still come as a disappointment to the industry.

The milk price is expected to remain at $4 this season and $4.60 for 2016/17 season as recent themes of strong growth in supply and lackluster demand show few signs of reversing any time soon. On the supply side, while Southern Hemisphere production is contracting as producers respond to lower prices and fear of worsening weather conditions (Dairy Australia is forecasting a 1%-2% fall in Australian milk production in the year to June, New Zealand production is likely to be down around 2%).

But Northern Hemisphere production, and in particular European milk production, is continuing to grow strongly. European milk production was up 5.3% in November compared to a year ago, while year to date production is running 2.2% ahead. This means Europe is producing around 2.7bn litres more milk in the 11 months to November than it did a year ago. To put this in context, NZ in total produced around 2.1bn litres of milk in the 2014/15 season.

More notably, European dairy exports are also expanding. The quantity of European SMP exports has increased 6% in 2015 compared to 2014, while butter exports are up a whopping 30%.

In contrast, while US milk production has also increased by 1.2% in the year to November (forecasts at a further 1.7% increase in 2016), relatively buoyant domestic demand for butter and cheese is soaking up some of this growth in supply.

US producers in particular are also benefitting from lower feed costs, which are providing some offset to falling milk prices.

Australia reported a trade gap of AUD 3.54 billion in December of 2015, an increase of 30 percent from a downwardly revised AUD 2.73 billion deficit in a month earlier and missing market expectations. It is the largest deficit since June last year as exports fell more than imports.

Multi-month we expect the US dollar uptrend to push AUD/USD lower, fuelled by a tightening Fed and weak commodity prices. We target 0.68. However, decent economic data and strong M&A inflows should see it outperform other commodity currencies, barring a further meltdown. While we expect to see NZD/USD lower towards 0.62 as the divergent monetary policies of the Fed and RBNZ play out.