The New Zealand Dollar Outlook Dims after Record Production Dents Milk Prices at Dairy Auction

Image © Rafael Ben-Ari, Adobe Images

- Dairy prices decline after production hits record levels in October. 

- Price decline dents NZD and cements downbeat RBNZ outlook. 

- Comes as currencies tread water in wake of stock market sell-off.

- China's Micron investigation could signal nasty turn in "trade war".

The New Zealand Dollar outlook has dimmed a touch this week after milk prices took another southward turn at the latest Global Dairy Trade auction and after data showed production of milk solids rising to a record high in October. 

Whole milk powder (WMP) prices fell by -1.8% at Tuesday's auction when markets had been looking for a 2% increase, knocking the New Zealand Dollar off two-month highs shortly after. 

Exports of milk and other agricultural goods are what underwrites the Kiwi currency so declines in prices have an adverse impact on the fundamentals of the economy and New Zealand Dollar.

"Our ASB colleagues anticipate ongoing New Zealand production strength will keep dairy prices soft over coming months," says Adam Myers, a currency strategist at Commonwealth Bank of Australia. "ASB has reduced Fonterra's 2018/19 payout forecast to $6.00 per KG (-25 cents). The easing in dairy prices will weigh on New Zealand real disposable income and encourage the RBNZ to keep the cash rate steady." 

The Dairy Companies Association of New Zealand (DCANZ) subsequently said milk production hit a record in October, feeding concerns about a possible glut of supply at a time when uncertainty about demand is mounting.

Production of milk solids rose 6% to an all-time high of 271,080 tonnes during the recent month while production of actual milk rose 6.5% to 3,299 tonnes.

The Department of Agriculture said Tuesday that U.S. milk production rose by a healthy 1% during the year to the end of October.

Moreover, the European Commission said last week that it has released 190,000 metric tonnes of milk powder back into the market after having used public money to buy 380,000 tonnes in 2015. 

The EC intervention was originally intended to boost prices earlier on, given the market was previously creaking under the weight of increasing supply. 

Easing dairy prices are unhelpful for a currency that has been badly damaged this year by Reserve Bank of New Zealand's (RBNZ) interest rate stance as they could cement an already-downbeat outlook for monetary policy. 

The NZD/USD rate was quoted 0.47% higher at 0.6822 Tuesday after rebounding overnight in response to a softening U.S. greenback, but it has declined -3.39% this year.

The Pound-to-Kiwi rate was -0.38% lower at 1.8759 and is down -1.15% for 2018, while the AUD/NZD rate was down 0.13% at 1.0613 and has fallen -3.19% this year.

"GDT surprised on the downside suggesting that global dairy demand may be faltering at the same time as NZ production is rising," says Richard Franulovich, head of G10 FX strategy at Westpac. "AUD/NZD is testing rising support but could still flush toward 2018Q2 lows around 1.0500 if risk aversion continues. In the interim we watch this trade an opportunistically enter on either a flush below 1.0550 or a shift in risk aversion."

Milk prices may be the headwind of the day for the Kiwi Dollar but other burdens are waiting in the wings nonetheless. Not least of all, another possible escalation in the "trade war" between the U.S. and China. 

"It seems investors are trimming overweight tech positions into year-end, re-assessing the role of the US –China trade war," says Chris Turner, head of FX strategy at ING Group. "The Nasdaq 100 looks to be breaking down from a two year bull trend and warns of another 8% correction.

U.S technology stocks opened lower Monday after the FT reported that Chinese authorities are investigating chipmaker Micron over alleged anti-competitive behaviour. This follows weeks of steep declines for the sector.

Losses were magnified and broadened out to emcompass the entire global market after the latest National Association of Home Builders (NAHB) index revealed signs of a possible slump in the U.S. housing market. 

The U.S. and Kiwi Dollars have seen mixed trading since, but outlooks for both are hinged almost entirely on an evolving Federal Reserve interest rate policy and on what happens next in the "trade war". 

China is New Zealand's largest trading partner and many of those milk exports that underwrite the Kiwi Dollar are shipped to the world's second largest economy.

As a result, anything that impacts sentiment toward China also tends to have an effect on the Antipodean unit.

China's Micron investigation may have served to return investors' focus to the trade conflict, which has been as significant a weight around the ankles of New Zealand's Dollar this year as RBNZ interest rate policy. 

Presidents from both the U.S. and China are due to meet on the sidelines of the G20 summit this month and markets have been optimistic a deal to de-escalate the tariff fight can be reached ever since news of the talks first emerged.

But hopes have ebbed since the Asia-Pacific Economic Cooperation summit ended in farce, with no customary joint statement being delivered at the end, after U.S. and Chinese officials clashed with each other over trade rules.

President Trump has imposed tariffs on $250 billion of China's annual exports to the U.S., citing "unfair trading practices", and threatened to target another $267 billion if the nation's leadership does not change course.

Technology is a hot-button issue because Trump alleges that Chinese policymakers have enabled and assisted the "theft" of U.S. firms' intellectual property. There's also a long history of bilateral suspicion around technology.

Trump pledged that he would lift a ban preventing Chinese telecoms firm ZTE from selling equipment in the U.S. earlier this year, but his efforts were initially scuppered by Congress. That ban led to severe financial hardship for ZTE, although it's not the first time Chinese tech firms have been blocked from entering or growing in the U.S. market.

The White House eventually prevailed in its bid to allow ZTE back into the U.S., but Trump followed up that victory by signing a bill that bans both ZTE and Huawei from servicing U.S. government agencies while the Pentagon has prohibited sale of their of equipment on military bases. Australia has taken similar action too.

China's allegations against Micron could well turn out to be legitimate, but they may also signal another nasty turn in the trade war, which ultimately sees companies' from both sides of the dispute subjected to efforts at sabotaging their positions in each market. This would almost certainly be bad for the Kiwi Dollar.

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