Lower dollar offers a little respite for exporters

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Conditions for dairy farmers have taken a turn for the worse in recent months. World prices for dairy products in the twice-monthly GlobalDairyTrade auction have almost halved from the record highs they reached in February.

We now expect Fonterra's milk price for this season to fall to $4.80/kg, which if realised would be the lowest since the 2008/09 season.

Several factors have conspired against milk prices this year. It's not surprising that global milk production has continued to rise, largely as a response to last year's high prices. But growing supply has collided with slowing Chinese demand, as well as Russia's ban on food imports from many Western countries (though not New Zealand), which has forced a lot of product on to the rest of the market.

One bad season is manageable; two in a row would be really problematic. So we're increasingly getting questions about the outlook for the milk price next season.

At the moment we're expecting something above $6, but there's a lot of water to go under the bridge yet. However, there's good reason to think that some of the factors behind this year's low payout will be temporary.

First, the slowdown in the Chinese economy is partly the result of policy tightening last year, as the government tried to clamp down on overheated parts of the economy, especially property development. The coming year is likely to see policy turn more stimulatory again, in order for the government to meet its economic growth targets.

In fact, there has already been a major loosening of policy around the housing market, which if successful should halt the decline in house prices and leave Chinese consumers a little more willing to spend.

Second, Russia's import ban was intended to be in place for one year, starting in August. Admittedly, whether it gets extended (or shortened) will ultimately be done for geopolitical reasons. But we suspect there won't be much appetite for an extended ban.

Just two months in, it is already proving to be as self-defeating as you might expect: prices in Russia have soared for those items that can no longer be imported, and enforcement is proving difficult.

A lower New Zealand dollar has provided a little relief for exporters. Having reached as high as 88c against the US dollar back in July, it has fallen as low as 77c in the last few weeks.

The Reserve Bank has done its part to encourage the move lower, describing the currency as "unjustified and unsustainable" and revealing that it had intervened to sell the New Zealand dollar in August.

But the case for a further decline in the NZ dollar is far from clear-cut, and it's notable that the market -- which loves a clear trend -- has been reluctant to keep pushing the currency lower. History shows that large, sustained falls in the NZ dollar are usually associated with recessions, often coupled with financial crises -- not our central view, and certainly not what anyone should be cheering for.

Much of the recent fall in the NZ dollar seems to be due not to local conditions, but to a rise in the US dollar, as the market has begun to anticipate interest rate hikes in the US. But again, the case here is far from clear-cut. The US central bank has warned that the global economy remains fragile, the US labour market has plenty of slack, and that a higher US dollar will depress inflation. We think that higher US interest rates -- and hence a sustained fall in the NZ dollar -- are more of a late 2015 story.