Why the U.S. Dollar and Foreign Exchange Rates Matter to Your Dairy
Jul 08, 2013
With more than 10% of U.S. milk production headed overseas, it’s more important than ever to understand the variables that drive exports.
By Atten Babler Risk Management, Commercial Risk Management Division
In past articles, we have discussed the increasing influence of the export market on U.S. dairy prices. With more than 10% of U.S. milk production now destined for the export market, it is now more important than ever to understand the variables that drive exports. One key variable is currency exchange rates.
The strengthening U.S. dollar has recently put exchange rates in the news. A number of factors, both realized and expected, have contributed to the strengthening of the U.S. dollar. Indications from the Federal Reserve, signaling an end to quantitative easing, have driven up interest rates and consequently the U.S. dollar. Additionally, signals of improving economic conditions, improving labor markets and rallying equity markets have increased the desirability of U.S. dollar-denominated assets.
U.S. dairy customers losing buying power
As the U.S. dollar strengthens, it reduces the purchasing power that our trading partners have when buying our goods. Commodities, including dairy products, are generally priced in U.S. dollars in the world markets. When the dollar strengthens, it becomes more expensive in foreign counties to purchase the same good from the U.S. Consequently, a stronger dollar acts to either ration foreign demand and/or reduce the price received by U.S. producers. This serves to limit the desirability of the product and consequently may also reduce its price in order to keep trade constant.
Figure 1 below shows the top five U.S. dairy export destinations, which include Mexico, Canada, China, the Philippines and Japan. Collectively, these countries make up over half of all U.S. export demand.
Figure 1 – Major U.S. Dairy Export Destinations (source U.S.DA FAS)
All of our top five dairy trading partners, with the exception of China, have seen their currency depreciate versus the U.S. dollar.
Figure 2 below shows the recent upward trend of the strengthening U.S. dollar. (This can also be viewed as a weakening of the foreign currency.)
Figure 2: U.S. Dairy Export Destination Exchange Rates (source OANDA)
Exchange rates and U.S. export competitors
When assessing the U.S. competitive position, it is also important to look at the currency trends unfolding for other major exporters. Major dairy exporters include New Zealand, the EU-27, Australia and Argentina, as shown in Figure 3 below.
Figure 3: Major World Dairy Exporters (source: U.S.DA FAS)
An analysis of exchange rates for competing exporters also signals potential headwinds for U.S. exports. The U.S. dollar has strengthened considerably versus the New Zealand Dollar, Australian Dollar and Argentine Peso. As these exporters’ currencies weaken they continue to sell their dairy products in the world market in U.S. dollars.
These U.S. dollars are increasingly able to be exchanged for more of the exporting countries currency. This serves to extend the in-country value of the U.S. dollar-denominated export sales. Even if dairy prices drop, these countries may be able to generate the same in-country revenue as long as the U.S. dollar strengthens proportionally. This helps maintain profitability and the appeal of exports for U.S. competitors.
Figure 4: U.S. Dairy Export Competitor Exchange Rates (source OANDA)
Currency prices are no less volatile than dairy prices or the weather. While it isn’t clear if we are seeing the beginning of a major trend, or a just a temporary appreciation of the dollar, it is worth noting that strength in the U.S. dollar has already impacted U.S. dairy exports. Dairy producers are encouraged to consider the risks posed by any loss of exports, whether caused by currency fluctuations or other factors, and pursue hedging strategies that secure a margin and limit downside risk in milk prices.
Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Contact Atten Babler at firstname.lastname@example.org.