Rural Fact or Fiction? El Niño was originally recognized by fishermen off the Pacific coast of South America in the 1600s.

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Ronald Lynch
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Baby booster November 21 Inside this edition: Rural Commodities Dairy 2 Time is not on my side Lamb 2 The wrong side of six Beef 2 From stellar to strong Forestry 3 Logs on firmer ground Financial

1 Baby booster November 21 Inside this edition: Rural Commodities Dairy 2 Time is not on my side Lamb 2 The wrong side of six Beef 2 From stellar to strong Forestry 3 Logs on firmer ground Financial Markets Interest Rates & NZD 3 Cuts coming; Down on two fronts Special Topic 4 Baby booster Key Rural Data: Pg. In this month s edition of Farmshed Economic we incorporate a Special Topic, titled Baby Booster. Here we discuss China s switch to a two-child policy and how this may kick-start a baby boom over the next ten years. Indeed, a Chinese baby boom spells good news for NZ food export demand and prices. Meanwhile over November, there has been little joy for dairy auction prices. Both auctions recorded price falls. As a result, we have trimmed our milk price forecast by 4 cents to $4./kg. That said, Fonterra s improved performance over the first quarter of the year and our continued positive long-run dairy outlook provide some offset. In lamb markets, prices above the $ per kg benchmark have proved shortlived. Furthermore, heading into 21, we struggle to see signs of fresh impetus. In contrast, beef prices continue to be strong compared to other rural commodity prices. For example, steer prices currently sit around 2% above the -year average. Moreover, we expect beef prices to remain at a historically high level over 21. Taking a look at forestry, log prices have largely tracked sideways since earlier in the year. From here, we expect log prices to improve, with lower inventories in the key Chinese market hinting that better prices are in store over 21. Meanwhile in financial markets, we have changed our interest rate view. We now expect the Reserve Bank to cut the Official Cash Rate (OCR) three more times, taking the OCR down to a low of 2% in the second half of 21. If we are right, then short-term interest rates will fall over coming months. Finally, since the last edition of Farmshed Economics, the NZD has followed dairy prices lower. With the Reserve Bank cutting interest rates and the US Federal Reserve likely to hike its own rates, we expect the NZD to remain under pressure heading into 21. Chart of the Month: As at 2 November 21 Current 4 wks ago Year ago Outlook* Rural Commodity Prices: ASB Dairy Price Index (USD) Lamb Price Index (NZD) Beef Price Index (NZD) ASB Forestry Index (USD) Interest Rates: 9-day bank bills year swap year swap Exchange Rates: NZD/USD NZD/CNY NZD/GBP Milk solids production (ytd % chg]** Fonterra Shareholders' Fund *Outlook indicates direction of change over the next months. **As at September 21.? 3 CHINA ANNUAL BIRTH NUMBER & FORECAST (annual birth of children, mn) Historical Birth Number Birth Number Forecast Rural Fact or Fiction? El Niño was originally recognized by fishermen off the Pacific coast of South America in the 1s. Answer on page 3 3 Nick Tuffley Chief Economist nick.tuffley@asb.co.nz Please refer to the important disclosures at the end of this document Nathan Penny Rural Economist nathan.penny@asb.co.nz

2 November 21 Rural Commodities Outlook Dairy Time is not on my side ASB Dairy Index, 2 Nov: % (mpc) There has been little joy for dairy auction prices over November. Both auctions recorded price falls, with overall and WMP prices now down 17% and 22%, respectively, over the last three auctions. However, with NZ production so far this season confirmed as weak and the outlook for further weakness, we see the current prices as out of whack with dairy fundamentals. Accordingly, we continue to point out that the market assumption that other producers like the EU will pick up NZ s slack is misplaced. Lost NZ exports are too big to cover. Once markets come to this realisation (most likely as stocks run down), we expect prices, particularly for WMP, will correct higher. However, this correction may be a month or more away. In particular, we ll be watching for any pick up in Chinese WMP imports for evidence of this correction is about to get underway. But time is not on this season s milk price side. We are nearing the half way point in terms of auction volumes sold, with a little over 4% of WMP sold so far. As a result, we have trimmed our milk price forecast by 4 cents to $4./kg. However, note our 21/17 milk price forecast remains unchanged. In other words, we continue to expect dairy prices to recover over 21 and dairy s overall prospects remain positive. Milk Price Forecast: 21/1 21/17 Long Run Fonterra ASB ASB ASB Milk Price* $4. $4. $. *per kg of milk solids (excluding dividend) $.-$7. $ MILK PRICE AND DIVIDENDS (per kg milksolid) Source: Fonterra, ASB Milk Price Dividend ASB Milk Price forecasts Long Run Lamb The wrong side of six Lamb Index, 2 Nov: % (mpc) Prices above the $ per kg benchmark (for 17.kg lambs) have proved short-lived. And with Christmas trade shipments having passed, prices are unlikely to head back over that mark again this season. Heading into 21, we struggle to see signs of fresh impetus. Strong UK lamb production is keeping prices subdued as there is a push to buy local from UK supermarket chains. Meanwhile, Chinese demand is sluggish, particularly while local production is also firm. In addition, the el Niño threat looms large for the sheep sector. Another dry summer would increase slaughter levels, and put prices under pressure much like last summer. An additional factor in the mix is the Silver Fern Farms restructure. In the short term, at least, we suspect that a debt-free Silver Fern Farms will be more comfortable paying a premium to secure its necessary volumes. Time will tell, however, on the longer-term impact on farmgate prices. Lamb NZD per kg 8 7 LAMB PRICES Sources: Agrifax Per kg calculation based on the NZ lamb schedule for 17.kg (net) $/head 3 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Beef From stellar to strong Beef Index, 2 Nov: % (mpc) Beef prices continue to be strong compared to other rural commodity prices. For example, steer prices currently sit around 2% above the -year average. That said, since the last edition of Farmshed Economics, beef prices have descended further from their earlier highs (as expected). Over the remainder of the year, we expect prices to drift lower. In particular, NZ is fast filling its 21 US quota. And filling the quota means that meat companies will divert beef to other lower-paying markets. NZ cents per kg BEEF PRICES (NZ P2 STEER) Heading into 21, the risks are more balanced as the US quota resets and supply may also moderate out of Australia. But this may be offset by the threat posed by el Niño. If a drought emerges and leads to increased slaughter, then prices may come under pressure. While the direction that prices head in the near term is unclear, overall we expect beef prices to remain at a historically high level over Sources: Agrifax 3 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun 2

3 November 21 Rural Commodities Outlook (continued) Forestry Logs on firmer ground Forestry Index, 2 Nov: % (mpc) Since the last time we reported on forestry back in March, prices have fallen 9% in USD terms. Log prices have accounted for most of this fall, with pulp prices largely tracking sideways over the 8-month period. The lower NZD, however, has more than cushioned the fall. Over the same period, the NZD has coincidentally fallen over 1% and as a result overall forestry prices are up a touch in NZD terms. From here, we expect log prices to improve. Importantly, the key Chinese market may have bottomed. Previously high Chinese inventory have moderated to the point where upward pressure on prices can return. This clearing of inventory may reflect the firming Chinese housing market, particularly in the major cities. Moreover, shipping costs remain very low, supporting returns. The other factor helping underpin prices is buoyant local construction activity. All up, we expect log prices to firm over 21. US dollars LOG AND PULP PRICES per tonne Source: Agrifax, Datastream 1 8 Financial Markets Outlook Pulp prices (lhs) Log prices (rhs) US dollars per tonne Interest Rates Cuts coming 9-day bank bills, 2 Nov: 2.87% no change We have changed our interest rate view. We now expect the Reserve Bank to cut the Official Cash Rate (OCR) three more times: at its December announcement, then again in June and August 21. The three 2bp cuts would take the OCR down to a low of 2%. OCR FORECASTS % (ASB vs pricing of overnight index swaps) % If we are right, then short-term interest rates will fall over coming months. Floating rates will essentially move down lockstep with the OCR, while other short-term rate will also move lower by lesser degree. Current shortterm rates already factor in some potential for OCR cuts. In contrast, longer-term rates are likely to track sideways. Rising interest rates in the US are likely to offset the impact of falling NZ short-term rates, with the net impact likely to leave these rates unchanged for the year. All up over the remainder of 21 and into 21, we expect that interest rates are likely to be either low or very low Current market pricing ASB Economics Forecast (peak of 3.% in 22) Source: ASB Sep-13 Jun-14 Mar-1 Dec-1 Sep-1 Jun-17 Mar- NZ Dollar Down on two fronts NZD/USD, 2 Nov:.7 -. (mc) Since the last edition of Farmshed Economics, the NZD has followed dairy prices lower. Over the four weeks the NZD has dipped around two cents against the USD. As at 2 November the NZD was buying US$.7. From here, we expect the NZD to remain under pressure, with the downward pressure likely to come from two fronts. Firstly, as mentioned above we expect the RBNZ to cut the OCR cut by 2bps in December and then by additional bps by August 21. If the RBNZ does cut, this will make holding the NZD less desirable and as a result it is likely to fall. Secondly, if the US Federal Reserve lifts its interest rates, the USD is likely to strengthen. Higher US interest rates will make holding US dollars more desirable, and conversely holding NZ dollars relatively less desirable i.e. the NZD falls. This view holds similarly for the NZD against the GBP. In contrast, we expect the NZD to hold steady against the euro and the AUD. In this case, respective central banks there, like the RBNZ, are also contemplating lowering interest rates.? US cents Trade-Weighted Index (RHS) Source: ASB NZ DOLLAR (past 3 months) NZD/USD (LHS) 2 28-Aug -Sep 9-Oct 3-Oct 2-Nov Rural Fact or Fiction? Answer: Fact! Indeed, the fishermen chose the name El Niño, Christ Child in Spanish, based on the time of year (around December) during which these warm water events tended to occur. Index

4 November 21 Chinese Demographics Baby booster Quarterly Special Topic China has relaxed its flagship one-child policy, introducing a new two-child policy. This policy and favourable demographics mean that China is likely to experience a mini baby boom over All up, this boom is likely to help underpin Chinese demand for NZ food exports. Summary China is big. Its economy, depending on the way you measure it, has developed into the world s largest; and on all measures, it will overtake the US in coming years. Moreover, roughly one in five people globally is Chinese. % 3 3 CHINESE SHARE OF SELECTED NZ GOODS EXPORT VALUES, 214 YEAR Dairy Source: Stats NZ For NZ, China s importance as a trading partner reflects its economic strength and population. For example in the 214 year, China accounted for 2% of the value of NZ s exports. With this in mind, the recent relaxation of China s one-child policy has potential to influence NZ s export outlook over coming years. Indeed, based on work done by our colleague, Wei Li, at the Commonwealth Bank of Australia (click here to read more), we expect that to be the case. Specifically, we expect an extra 1. million babies annually over the next ten years plus ongoing household income growth to underpin Chinese demand and prices for NZ food exports. In terms of the lucrative Chinese infant formula alone, the policy is estimated to generate a lift in demand by over 1%. With this in mind, this extra demand helps us reaffirm our long-run milk price forecast range of $. to $7./kg of milk solids. As for other food exports like meat and horticulture, the baby boom is positive for their demand outlook at the margin, although Chinese income growth and changing preferences will remain the key demand drivers. China is likely to experience a mini baby boom With the new two-child policy and other factors, we expect China to embrace a mini baby boom over Average annual births are likely to rise from 1.1 million in 2-1 to million in We expect the new two-child policy will lift China s second birth fertility rate from 1.1% currently to 1.% by 217. What this means is that the share of women in China that have two kids is expected to increase from 38% in 214 to % after Meat Kiwifruit Total Goods CHINA CHILDBEARING AGE WOMEN (number of childbearing age women by age) CHINA ANNUAL BIRTH NUMBER & FORECAST (annual birth of children, mn) Historical Birth Number 1-49 Years Old (lhs) Birth Number Forecast 3 A higher second birth rate will lift the number of second children in China. Our estimation is that the number of second children in China will increase from million annually in 2-14 to. million annually in 21-. Besides expectations that more Chinese families will have two kids in the future, there are other factors also in play reinforcing the lift in baby numbers Years Old (rhs) 1 14 Firstly, the number of women between 2-39 years of age in China is set to pick up materially over In the early 21 s the number of childbearing women reached a low approaching 14 million. But by the early 22s, we expect that number to rise steadily above 1 million Also, we expect birth numbers to catch up to the high recent number of marriages. In the past, the number of births usually follows closely with the number of marriages. However, recently this has not been the case. We suspect that couples have postponed having children; a 4

5 November 21 Quarterly Special Topic (continued) phenomenon common as a countries becomes richer. As a result, we think the strong rally in the number of marriages in the past six years should soon translate into a pickup in number of births. Looking back at China s flagship one-child policy China adopted a one-child policy in the late 197s. Before that, having more kids was encouraged as the then-leader believed more people equalled more growth CHINA MARRIAGE & BIRTH NUMBER (annual number, mn) Marriage Number (rhs) After almost four decades, the one-child policy was officially relaxed in 213 by allowing couples with at least one partner from a single-child family to have two children. Then in 21, the one-child policy was fully abolished and replaced by a two-child policy, permitting all couples to have two kids. The degree of enforcement of the one-child policy has varied greatly in times and in different circumstances. For example, the one-child policy was much more strictly enforced in the 198s and 9s. Whereas by 21, a great number of cities in China have quietly relaxed the onechild policy, allowing selected couples, such as those with both partners from a one-child family, to have two kids. Moreover, the one-child policy has always been more restrictive on urban families than on rural families (81% of the Chinese population were rural in 198; the share fell to 4% in 214). In practice, a rural couple is usually allowed to have a second child if their first kid is a girl, because of the need for males in heavy farming activity. For the ethnic minority groups in China, the one-child policy is not applicable either As a result, it would be a mistake to assume most Chinese families 8 have only one child. Even before the relaxation of the one- child policy 2 in 213, the second birth fertility rate in China had averaged 1.% from In other words, roughly 3% of childbearing age women in China were already allowed to have a second kid under the one-child policy (before its relaxation in 213) Index June '2 base 1 Source: Stats NZ NZ EXPORT PRICES TO CHINA Birth Number (lhs) Nevertheless, the one-child policy has played a big role in slowing population growth in China. Following the implementation of the one-child policy, China s population growth rate fell from an average of 2.% per annum in the 19s and 7s, to just.% in 214. The fertility rate also declined from over 14% in 19s to about 3.7% in 214. If China did not implement the one-child policy, its population would have exceeded 2.1 billion in 214, rather than 1.37 billion. In other words, the one-child policy has resulted in some 7 million fewer births in China in the past three decades. Outlook for NZ food exports to China All up, we expect this mini baby boom to result in a sustained lift in demand for food, with a lift in dairy demand potentially as soon as nine months away. As a result, we expect this lift to underpin prices of NZ food exports to China. And by way of example, these extra mouths to feed help us reaffirm our long run milk price forecast range of $. to $7./kg of milk solids. 9 7

November 21 ASB Economics & Research Phone Fax Chief Economist Senior Economist Senior Economist Rural Economist Economist Nick Tuffley Jane Turner Chris Tennent-Brown Nathan Penny Kim Mundy nick.

6 November 21 ASB Economics & Research Phone Fax Chief Economist Senior Economist Senior Economist Rural Economist Economist Nick Tuffley Jane Turner Chris Tennent-Brown Nathan Penny Kim Mundy (49) 31 9 (49) (49) 31 (49) (49) 31 1 (49) ASB Economics ASB North Wharf, Jellicoe Street, Auckland Important Disclosures This document is published solely for informational purposes. It has been prepared without taking account of your objectives, financial situation, or needs. Before acting on the information in this document, you should consider the appropriateness and suitability of the information, having regard to your objectives, financial situation and needs, and, if necessary seek appropriate professional or financial advice. We believe that the information in this document is correct and any opinions, conclusions or recommendations are reasonably held or made, based on the information available at the time of its compilation, but no representation or warranty, either expressed or implied, is made or provided as to accuracy, reliability or completeness of any statement made in this document. Any opinions, conclusions or recommendations set forth in this document are subject to change without notice and may differ or be contrary to the opinions, conclusions or recommendations expressed elsewhere by ASB Bank Limited. We are under no obligation to, and do not, update or keep current the information contained in this document. Neither ASB nor any person involved in the preparation of this document accepts any liability for any loss or damage arising out of the use of all or any part of this document. Any valuations, projections and forecasts contained in this document are based on a number of assumptions and estimates and are subject to contingencies and uncertainties. Different assumptions and estimates could result in materially different results. ASB does not represent or warrant that any of these valuations, projections or forecasts, or any of the underlying assumptions or estimates, will be met.

More OCR cuts and lower mortgage rates expected

Home Loan Rates July 201 More OCR cuts and lower mortgage rates expected We expect the RBNZ to cut the OCR by an additional bp this year taking the OCR back to 2.% again by year-end. Influential global