Strengthening demand and prices drive the outlook for Canadian dairy at mid-year
FCC Economics is doing a mid-year check-in on our January 2019 Outlooks. Throughout July and August, we’ll update our expectations about profitability across seven Canadian ag sectors (dairy, broilers, red meat, food processing, horticulture, agribusiness and grains, oilseeds and pulses). We’ll describe what’s happened in 2019 to-date and what you should monitor in the next six months.
Growth in Canadian milk production slowed at the beginning of 2019 as we anticipated in our January outlook. The farm milk price recorded gains larger than anticipated, accompanied by a higher increase in input costs. This resulted in tight profitability for dairy operations. We expect break-even profit margins in the P5 milk pool for the remainder of 2019 (using industry average cost of production and butterfat composition). Margins in the Western pool should be positive. The pools’ profitability outlooks differ mostly because of their shares of industrial milk relative to shares of fluid milk.
Strength in retail demand for dairy products
High butter inventories
Prices for SNF trending higher
Rising feed costs
Higher interest expenses despite no change in the Bank of Canada policy rate
Butterfat production declined 0.8% year-over-year (YoY) in the first 3 months of 2019. The average farm price in P5 and WMP provinces climbed 6.5% YoY in the first quarter of 2019, pushing cash receipts 4.2% higher in the first quarter of 2019 relative to 2018 Q1.
Two factors helped raise the milk price:
A 4.8% increase in butter’s support price, effective September 1, 2018.
Prices for solids non-fat (SNF) have been trending higher in 2019 – good news, given the share of SNFs marketed at prices based on world skim milk prices. USDA projections call for a 26.5% YoY increase in the average U.S. price of non-fat dry milk this year.
We estimate production costs climbed 3.2% YoY on average in the first quarter of 2019. This was mostly due to higher feed, energy prices and interest expenses. Feed costs are projected higher for the second half of 2019 as unfavourable seeding conditions in the U.S. result in lower 2019 seeded acres and corn yields. The USDA projects an average 2019-20 corn price of US$3.80, higher than the 2018-19 average of US$3.60. Futures markets currently signal that this price projection is too low. Dry conditions in Prairie provinces and an excessively wet Eastern Canada could also lower the available supply and/or quality of feed.
Milk production in recent years has increased to meet total market quota requirements and rebuild stocks. Canadian butter stocks reached 42,000 tonnes in April, representing a 19.2% YoY increase. Going forward, production will need to mirror market requirements based on the evolution of domestic demand, accounting for the recent implementation of the CPTPP and CETA and domestic processing capacity.
Strong retail demand, arising from advantageous retail dairy prices, consumer income and food preferences, will be needed to maintain production growth. Those conditions look promising.
Canadian overall food prices climbed in May, amounting to a 3.5% YoY increase. Dairy product price trends compared favourably in the first four months of the year, but inflationary pressures are now appearing. Butter and fresh milk prices rose in May by 5.8% and 3.9% YoY, respectively, while cheese prices were up 0.3%.
Growing incomes have also helped spur demand. Canada’s unemployment rate fell to 5.4% in May 2019 (the lowest level since 1976) and average hourly earnings grew at a 2.8% annual pace.
Interest rates and the value of the Canadian dollar have had an impact on the profitability of Canadian dairy producers in the first half of 2019.
The Canadian economy recorded a 0.4% increase in real GDP in the first quarter of 2019, following a 2018 fourth-quarter 0.3% increase. The Bank of Canada (BoC) expects the pace of economic growth to pick up in the second half of 2019, with inflation expected to trend around the bank’s 2% mid-point target.
A slower pace for economic growth has significantly changed the January outlook for interest rates. We don’t expect the BoC to lift its policy interest rate for the remainder of 2019, yet financial markets believe a rate cut is possible. Recent investments and the five previous increases in the BoC policy rate (dating back to July 2017) are expected to continue pushing interest expenses of dairy operations higher.
Our January forecast of a US$0.75 loonie was right on the money up to mid-June. The future path of interest rates in Canada and the U.S. as well as the strength of the oil market matter for the exchange rate outlook.
The U.S. economy has shown some strength with a 3.2% increase in real GDP for the first quarter of 2019, in line with the 2018 economic performance. But in March the U.S. Fed chairman slashed the forecast for 2019 rate hikes from two to zero. And the most recent statement of the U.S. Fed now suggests at least one rate cut before the end of the year. Lower U.S. rates could lift the loonie up slightly.
Conversely, potentially lower oil prices weaken the outlook for the loonie. Supply disruptions and production controls resulted in the West Texas Intermediate (WTI) crude oil price averaging US$57. The Canadian oil price benchmark also rebounded following production cuts in Alberta earlier this year. Yet, world economic growth has slowed (in line with early 2019 expectations) due to trade tensions, weakening global oil demand.
FCC Economics forecasts the CAD to trend around US$0.745 for the remainder of 2019. A low loonie contributes to a higher price for solids non-fat and supports the producers’ milk price. It also implies a slightly higher price for feed.
CUSMA’s ratification process
Federal-provincial working groups’ recommendations to support industry compensation and adjustments to CUSMA and CPTPP.
Possible slowdown in U.S. economic growth and the response of the U.S. Federal Reserve. Trade tensions can hamper world economic growth.
China’s dwindling import demand for whey used in feed rations because of the African Swine Fever impact on the hog herd. This is compounded by China/US trade tensions.
Vice-President and Chief Economist
Jean-Philippe (J.P.) Gervais is the Vice-President and Chief Economist at FCC. His insights help guide strategy and monitor risk throughout the corporation. In addition to acting as an FCC spokesperson on economic matters, J.P. provides commentary on the agri-food industry through videos and the FCC Economics blog.
Prior to joining FCC in 2010, J.P. was a professor of agricultural economics at North Carolina State University and Laval University. He’s also a past president of the Canadian Agricultural Economics Society (CAES). J.P. earned his Ph.D. in economics from Iowa State University in 1999.