With news of a deal between the US and China nearing, it seems as though the Dairy farmers and producers will be getting the demand support that they have sought in the recent months. Nothing has been announced, but the general optimism with those familiar with the matter seems to signal that an end is near. This can only show positive signs for a surging dairy complex that, until very recently, was seeing seasonally low prices and bearish signals. Additionally, recent souring sentiment from the White House regarding trade policy with the EU looms in the background. A trade dispute with the EU may be far more damaging to the dairy complex than what has happened with China as the US relies heavily on European dairy imports. With cheese markets finally normalizing in the $1.60’s, what would be in store for the industry with this increase in volatility?
US exports of dairy products are still strong by most measures: the net trade gap closed the year 8.5% higher vs year prior (see our monthly market report for more detail). But the last few months have shown a turning of the tides, with exports down in total and especially with some of its largest dairy trading partners (including double digit decreases in Mexico over the last couple of months, the largest US dairy trading partner). While dairy is one of the smaller trade items with China, the US still saw roughly 166,000 Metric Tons of dairy products (365 Million Lbs) leaving for China in 2018, according to the US Dairy Export Council (USDEC), it doesn’t mean that US farmers and producers are okay. We saw the government announce protection for those farmers due to low farm gate prices received as a result of retaliatory tariffs and now, as more tariffs loom with our European trading partners, a new round of support has been announced. The general sense around our circle is that farmers would rather have the income from a stronger market than be receiving government subsidies for a lack of one.
Chinese dairy imports from the US are down in the beginning of 2019, while Chinese demand for dairy products remains strong. This is reasonable, considering China is still consuming product and the tariffs have likely priced the US out of certain markets. Chinese consumers still need to get their products from somewhere. But what we think has surprised people is the strength of this demand. The most recent Global Dairy Trade Auction saw prices rise due to strong demand for the ninth auction in a row, going back into 2018. Driving most of this growth is North Asia, dominated by China, which ate up 50% of the product offered in the most recent auction. Could this be the new norm? Do we expect China to grow its dairy demand going out into the future? Well, yes and no. Our long-run forecasts have Chinese demand growing in perpetuity, so long as overall economic growth meets certain thresholds, but we also believe that this most recent bout of demand seems to be a pattern of bulking up or pre-purchasing product for future demand.
As for Europe, of which 76% of all US cheese imports come from, the image is far less clear. We don’t know what these tariffs will look like, or if they will even happen. But we are preparing for the worst and maybe we will be pleasantly surprised. The proposed Tariffs would only fall on about 72% of cheeses imported from Europe, so the net effect will be on 55% of US total imports. Since much of the cheese produced in Europe falls into the “specialty” category, we don’t see easy replacements with domestic product. This means that Tariff will most likely fall on the consumer.
All else being equal, both of these events happening at the same time could skyrocket milk prices, albeit in different ways. returning demand from China will drive powder prices higher in a frenzy to meet this demand. While a supply shock from an imposed tariff on Europe would require more affordable domestic cheeses to fill in gaps. Both of these happening at the same time would put dairy products in short supply. The hardest effects of these outcomes would fall on the purchasers, not producers of dairy products as they would be stuck paying for government imposed tariffs on products that aren’t readily substitutable. All of this is to say: don’t be surprised when we see $1.80’s cheese markets in the near future.