Dairy Outlook: Strong Domestic Market Tempered by Mixed Export Market
Monday, February 20, 2017
Posted by: David Bullock, Senior Economist, AgriBank
To borrow from the TV weather playbook, the 2017 forecast for domestic dairy product demand is generally sunny, while potential storm clouds may be gathering on the horizon for export markets. Let’s take a closer look at key factors driving each outlook:
Rising consumer confidence. Generally, domestic dairy prices rise and fall on demand for cheese and butter products, since over 90 percent of those finished products are sold to U.S. consumers. The sales of those products are strongly correlated to consumer confidence and, in that regard, things are looking up. For example, the Conference Board’s Consumer Confidence Index hit a 13-year high of 113.7 in December, reflecting strong optimism on U.S. spending and economic conditions. Similarly, the Restaurant Performance Index (RPI) moved up 0.2 percentage points in November to 100.7, as operators expressed increasing optimism about future dine-out traffic. Both of those indicators bode well for forward-looking domestic sales of cheese and butter products.
Healthy demand. Without question, cheese has been the growth engine in the dairy commodity portfolio, helping offset a steady decline in fluid milk sales. In fact, domestic consumption of cheese products rose an estimated 3.4 percent in 2016, the sixth-consecutive year of overall growth. After an off year in 2015, domestic consumption of butter and milkfat products rose 5.8 percent last year.
Strong pricing outlook. The outlook is supportive of higher prices during 2017, as evidenced by the Class III futures market, where forward pricing in 2017 currently ranges from $16.56 for February deliveries to a peak of $17.83 per hundredweight (CWT) for delivery in August and September. This is a solid improvement over 2016, when Class III prices actually dipped as low as $12.76 per CWT last May. (Source: http://www.cmegroup.com/trading/agricultural/dairy/class-iii-milk.html)
Mild economic pressure. The average cost of 16 percent protein feed (USDA Agricultural Prices) is expected to rise about $0.40 to $7.70 per CWT of milk in 2017, due to higher prices for corn and soybeans, assuming a return to trendline yields. In addition, expected interest rate hikes this year will most likely curb herd expansion plans. Both of those factors will keep a lid on overall production growth, helping boost market pricing.
On the export side of the ledger, the overall picture is much more mixed. Consider the following:
Lower global production. On a positive note, milk production is down for several key global competitors. For example, collective deliveries from the European Union tailed off in the second half of 2016 and were well below production levels from the previous year. Similarly, production from New Zealand dairies was down 3 percent through late 2016, while Australian milk product deliveries were off more than 10 percent. This offers an opportunity for the U.S. dairy industry to boost market share, particularly for non-fat dried milk (NFDM), a segment in which exports already represented 52 percent of total U.S. sales in 2016.
Strong dollar headwinds. After a brief dip last spring, the U.S. dollar has again strengthened against other global currencies, putting downward pressure on a range of export commodities, including NFDM. As of late January, the NASS/AMS price for non-fat dried milk was 1.0285 per pound, up from 0.7695 per pound just a year earlier. However, the dollar is expected to strengthen even further in 2017, which could hold down exports and pricing power for U.S. NFDM and whey powders. (Source: http://future.aae.wisc.edu/data/weekly_values/by_area/1627)
Political risks. To date, the Trump administration has announced its intent to renegotiate the North American Free Trade Agreement (NAFTA), and has also floated the idea of a 20 percent tariff on products imported from Mexico. The potential for retaliatory trade actions pose high risk for U.S. dairy exports, particularly in NFDM, since over one-third of U.S. overseas sales have gone to Mexico during the past five years. And, while cheese represents only about 5 percent of overall dairy export sales, Mexico is the top destination for those products. For that reason, a trade war could significantly depress NFDM and cheese exports to a key and reliable U.S. trading partner in dairy products.
Summary. Overall, the market fundamentals point towards Class III values holding in the $16 to $18 range over the coming year, as domestic demand is expected to remain strong with the overall improvement in the U.S. economy. However, a higher dollar and uncertain trade policy will inject a high degree of volatility into the market outlook, particularly for those product categories that depend upon exports for a significant portion of their demand such as nonfat dry milk and whey powders.