Last year in the State of the Industry issue, I wrote about recession and modeling the impact of economic growth on dairy demand. Well, after 12 months of nearly continuous tightening by central banks around the world, the anticipated recession is finally … still not here.
While we haven’t technically entered a recession in the US, demand has weakened significantly this year and we’re seeing that reflected in dairy prices that are down 15 to 40% from last year in July. The drop in dairy prices has now pulled milk prices down below the cost of production for most dairy farmers. The underlying stories for the second half of 2023 and into 2024 will center around the eventual improvement in demand along with how quickly, and to what degree, the supply side will adjust lower.
It is hard to pin down the exact macroeconomic drivers of the slowdown in demand. The economy is still growing. The unemployment rate is near a record low. Wages are growing. Inflation is cooling. But consumers are still in a bad mood and dairy demand is weak. Weak demand is likely being primarily driven by two things: the hangover from the rapid increases in spending during 2021/2022 and the negative impact the widespread inflation has had on household budgets.
Both the surge in spending and the hangover can be seen in US retail sales data. From 2014 to the end of 2019, retail sales increased by about $14 billion a year on an annualized basis. But from mid-2020 to mid-2022, sales increased by $56.7 billion per year. Spending on goods increased at four times the normal pace during the pandemic and early post-pandemic period, which is obviously unsustainable. Retail sales hit about $590 billion in March of 2022, and they have effectively stuck there since. It’s as if consumers have set their budget and that is all that they are willing to spend at the store each month.
While inflation has cooled, prices are still rising on top of two years of strong price increases. That means each dollar spent buys fewer and fewer physical things, and consumers have been reluctant to spend more dollars, so the total volume of goods purchased has been declining.
On the positive side, consumers have still been willing to spend more on services, such as restaurants. But even there, higher menu prices mean that the volume of food and drinks being purchased through food service likely fell below year ago levels during the second quarter of this year while the estimated volume of food being purchased through retail has been below year ago since January. To compound things, we’re seeing the same type of consumer behavior and sales in Europe, which is leaving excess product available globally as well.
Where does demand go from here? Consumer sentiment has improved a little recently, but I’m not sure it is going to translate into more spending. Inflation has cooled, but core inflation is still running much stronger than the Federal Reserve would like to see, and the odds are that they continue to try to slow the economy in order to bring core inflation down, which may lead to a weaker job market and higher unemployment late this year and into 2024.
With this in mind, it’s hard to see the economy helping dairy demand; but what will help is the lower dairy prices. The 15-40% decline in commodity prices is feeding through to lower retail prices and restaurants, especially pizza restaurants, might start to run more promotions with cheese prices down. Demand will likely improve a little, but without a big improvement in the macro economy and consumer sentiment, demand probably won’t be strong.
The milk supply is not excessive, and it will be getting smaller. YTD milk production is only up 0.8%, which is below the long-run average growth of 1.3%. Feed costs for dairy farmers are shifting lower, but even with corn at $5.00 a bushel the breakeven for dairy farmers is likely around $18.00 Class III milk. Right now the Class III futures market for the second half of 2023 range between $13.80 and $17.75. So the market is telling farmers that they will be losing money for at least the next six months. In response, farmers are expected to cut the size of the dairy herd. YTD dairy cow slaughter is already up 5.8% and should remain strong in the second half of the year.
While the dairy cow herd is expected to get smaller, milk production per cow is expected to grow as feed costs come down. That could keep milk production growing between 0.5% to 1% during the second half of the year despite the strong slaughter. I think it is going to be February or March before we see milk production finally falling below year ago, although it could happen sooner if dairy prices stay very weak.
It is hard to get excited about demand, but lower prices should give us a small boost in the second half of 2023 and early 2024. Farmers are starting to adjust production in response to low milk prices and negative margins, but it is a relatively slow process that will likely take 12 months to play out. With dairy prices currently below the cost of production for dairy farmers, we can confidently say they will eventually move higher, but it is hard to call the exact turning point.
Editor’s note: This material should be construed as market commentary, merely observing economic, political and/or market conditions, and not intended to refer to any particular trading strategy, promotional element or quality of service provided by the FCM Division of StoneX Financial Inc. (“SFI”) or StoneX Markets LLC (“SXM”). These materials represent the opinions and viewpoints of the author, and do not necessarily reflect the viewpoints and trading strategies employed by SFI or SXM.
Nate Donnay is the Director of Dairy Market Insight at StoneX Financial Inc. and has been applying his expertise in large complicated systems and statistical analysis to the international and US dairy markets since 2005.