Australia caught in game of currency roulette

By Steve Spencer

While the world market for dairy products is in much better shape going into the 2017–18 southern production season, there are still a few risks that may weaken milk prices for Southern Australian dairy farmers.

One of those is the value of the Australian dollar. Our own estimates of the 2017–18 farmgate price are based on an important assumption that the local currency will average US$0.76 for the season.

A few short weeks ago that looked a pretty safe number, but recently the A$ has soared, back past US$0.80 for a short while, settling back below that at the time of writing.

The exchange rate, as farmers never tire of hearing, is fairly critical in the scheme of things. A 1¢ shift in the A$ against the US, with all else being equal in theory, affects the value of milk at farmgate by 10–12¢/litre.

So if there is a permanent 4¢ hike in the dollar, and nothing else changes, that could punch a big hole in full year expectations, potentially meaning opening prices remain as closing prices.

Of course, that depends on individual company exposures to currency in product pricing and it depends what happens to other currencies. I’ll come back to that.

Why has our dollar surged? Well our business is not skilled in the analysis and forecasting of currency movements. But we watch developments and understand the strong influences, so we can understand the upside and downside risks that lie ahead. So this is my unskilled, layperson view of what seems to be out there driving the dollar.

Lately much of the strength in the Australian dollar seems to be due to weakness in the US currency, which has also fallen against the Euro and even the Japanese Yen. In 2017, after the election of Donald Trump as the self-proclaimed reformist, this is not how the script was written.

Trump was going to take the shackles off the US economy, spend big on infrastructure and fix the big bad budget deficits. The US dollar was supposed to strengthen. It wasn’t always clear how this was going to help boost US trade.

It’s done the reverse. The Trump administration chaos appears to be worsening, with an unhinged President more besotted with media opinion, Twitter likes, his hair, and undoing anything Obama did, rather than making sound decisions and listening to experience, ensuring few of his reform agenda items get up.

The financial markets have lost faith in the ability to restructure the US balance sheet and finance big spending plans. As a result, the US dollar has slid more than 10 per cent against the Euro since early March.

Europe’s currency is staging its own revival in the process with a brighter outlook for the big economies in the bloc, and more optimism about leadership with the outcome of Dutch and French elections, where right-wing isolationists were rejected by the people.

When we come back to our dollar, there’s always talk of the influence of “relative interest rates” — the difference between the cost of money in Australia versus the US.

With money markets figuring there is a smaller chance of interest rate rises in the US, and ongoing heat in the property market in Australia, this helps talk up the value of the local currency.

More money would therefore flood into the A$ to get the benefit of higher interest rates compared to the US and other low-interest economies.

This doesn’t always hold — the other big variables that affect the value of the A$ are commodity prices for metals and, in particular, iron ore, due to the importance of those commodities to export earnings and Australia’s trade balance ….even though the mining boom is over, right?

The chart on this page shows the close tracking of the value of the A$ and iron ore prices in the past 4 years. There is clearly something in that.

We can’t look at US v Australia currency rates in isolation. In some dairy commodities, such as cheddar cheese, butter and skim milk powder, where the volume of EU exports is significant, European wholesale prices (expressed in Euros) strongly influence world market prices against which other exporters compete.

With a stronger Euro, the US$ value of prices sought by European exporters will rise, driving higher prices in the trade — and hence a rising A$ may offset only some of the gloss from those gains.

That won’t always work — it depends if another big exporter such as the US itself or New Zealand gets aggressive and seeks to buy greater market share.

Where is the dollar going? Most currency experts sitting in big banks and finance houses tip the Aussie to fall against the US in the coming year.

Some see it falling hard into the low 70 cents territory, and staying there. If that happens, it could be a boon for Australian dairy farmers in the next couple of seasons, sorely needed to improve farm cash flows … and confidence in this industry.

• Steve Spencer is a director of