Weekly Economic Commentary 12 June 2023
Analysis and forecasts of the economy and markets, along with previews of data for the week ahead.
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Cheese cutter.
Global dairy consumers have fallen in love with cheese, with cheese prices sizzling at or near record highs since late 2021. While increasing global consumption of dairy products is normally a good thing for New Zealand, we are not well-placed to immediately benefit from higher cheese prices. With Chinese dairy demand also taking longer to rebound than anticipated, we have revised down our view of total dairy export and farm incomes and the 2023/24 farmgate milk price forecast.
Pinning down the exact genesis for the cheesy trend is a question for the marketing experts – however, we suspect it has something to do with Covid lockdowns, the ease of pizza deliveries during said lockdowns, and therefore a new-found love of cheese in large fast-growing markets, particularly in Asia.
New Zealand dairy companies have limited capacity to produce more cheese. Cheese production has expanded where possible, but generally companies are stuck producing other less profitable products like whole milk powder (WMP). As a result, New Zealand cannot optimise the average price of dairy exports given the current mix of global dairy product prices. Put differently, total dairy export values would be higher if New Zealand dairy companies could produce more higher value cheese products and less WMP. We note that in larger cheese producing regions such as the EU, average dairy prices are higher and thus total dairy incomes are faring better.
Cheese and WMP normally track each other, so there normally isn’t a large trade-off between producing one over the other. However, over the last year or two, cheese prices have never been higher relative to WMP.
At the same time as cheese prices have boomed, WMP prices have continued to drift lower this year. Indeed, we had expected WMP prices to have turned up by now. We put this down to a slower than expected recovery of Chinese dairy demand and the Chinese economy more generally.
With the above in mind, we have lowered our 2023/24 milk price forecast to $8.90/kg, down from $10.00/kg previously. This puts our forecast slightly above the top end of Fonterra’s forecast range of $7.25/kg to $8.75/kg.
At the same time, we expect high Fonterra dividends for farmers over the season just gone and also for 2023/24 (Fonterra’s cheese profits are paid as dividends to farmers rather than reflected directly in the milk price). This is a new development given the low dividends Fonterra has paid over recent years.
Last month, Fonterra said that it expects normalised earnings per share of 65-80 cents for 2022/23. Assuming it pays 70% of its earnings as a dividend, this equates to a dividend of between 45.5 and 56 cents per share.
We anticipate that Fonterra will continue to pay a similar dividend over 2023/24. Adding this together to our milk price would equate to between $9.36/kg to $9.46/kg. In other words, the healthy dividend does not fully offset our lower milk price forecast (as Fonterra cannot fully capitalise on very high cheese prices).
Looking ahead, there are two key questions for dairy markets. Firstly, how soon can Fonterra and/or other dairy companies start to produce more cheese? And secondly, when will Chinese dairy demand come through more strongly?
For now, we assume that dairy companies cannot expand cheese production easily so the cheese price strength and relative WMP weakness persist over the year. However, if New Zealand companies can produce significantly more cheese in the next 12 months (and sooner than offshore rivals), then cheese prices will fall and WMP prices will rise, taking the milk price higher.
On the Chinese demand front, we expect the recovery will eventually pick up steam. For example, overall Chinese consumer demand remains firm, and we expect it to build broader momentum, including demand for dairy products, over the year. As a result, we expect that WMP prices will turn and lift gradually over the new season. All up, we expect these factors will lead to a gradual improvement in the milk price outlook and thus support our relatively positive milk price forecast.
GDP should show a less overheated economy but migration should remain strong.
Meanwhile, we expect a 0.4% drop in GDP for the March quarter, following on from the 0.6% fall in the December. We wouldn’t describe this as a recession given the very strong labour market and general uncertainty on the quarterly drivers of GDP due to fluctuating seasonal factors and climatic events. Rather, we’d characterise the economy as ‘less overheated’ rather than ‘weak’. Indeed, despite the expected fall in output the economy is still running well ahead of the potential growth rate where inflation remains stable and low. Thus, a substantial cooling-off period is needed to bring inflation fully under control.
Meanwhile, this week’s migration and housing market data will be of key interest to assess to which strength in population growth is translating to broader economic strength. The current account deficit is likely to remain very elevated hinting at a still overheated economy.
Either way, monetary policy is starting to get traction in slowing the economy. But with annual inflation still closer to seven than six percent, it’ll be a considerable period before the RBNZ can even hint at declaring victory.
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