No two situations are ever the same, and caution must be applied when comparing the current dynamics in the US dairy market with other moments in history. It is worth at least noting the impact on US milk supply of two past major events.

The first precedent to consider is the 1988 drought. This was the last time the US experienced a drought comparable in spread and severity to this year’s. In 1988, national milk supply actually rose 1.6 percent YOY, an acceleration on that seen in the prior year.

Though cow numbers fell, this was very much in line with the medium term trend during that period, and was more than offset by rising yields per cow.

The lack of significant impact on milk production volumes from the 1988 drought highlights the very different interface between droughts and milk production in the US compared to similar events in regions like Australia and New Zealand. In the latter regions, where pasture-based feeding is more common, a bad drought can drive supply 10 percent below prior-year levels. By extension, it also supports focusing on the IOFC metric as the key expression of impact on the US dairy industry.

The second precedent to consider is the market slump of 2008/09 in the wake of the global financial crisis. While seasonal conditions were relatively normal in 2008/09, US producers saw their IOFC slump from USD 10/cwt in Feb 2008 to under USD 4/cwt within 17 months, as the crisis battered the global dairy market. Largely as a result, milk production growth dried up completely.

The worst of the impact on milk supply was not evident until six months after the measure fell below USD 4/cwt. Recovery in milk production growth clearly lagged the relatively sharp improvement in IOFC that occurred through 2009/10, with milk supply only returning to growth after IOFC had been above USD 8/cwt for four months.

The stalling of US milk supply growth in 2008/09 is disconcerting when we compare it to the current US situation. The collapse of IOFC over the last 17 months almost mirrors that seen in 2008/09. The current futures curve suggests a slower recovery in this measure than was evident coming out of the global financial crisis.

The use of futures contracts for hedging purposes is still fairly limited amongst US dairy producers, with liquidity limiting even those who do participate to three to six month’s coverage. As such, most producers will be exposed to market pricing in coming months.

In our Global Dairy Quarterly (GDQ) released on 27 June, we forecast 0.8 percent growth in US milk production in YOY terms in July–December. While it is still too early to call the full impacts of the drought, for the time being we have revised our forecast to 0 percent growth for this period. Anecdotal evidence suggests that national milk production may even be showing 0 percent growth YOY as early as July.

Earlier–than-anticipated price rally is bottom line for global markets

Prior to the onset of the US drought, Rabobank had expected the US dairy export surplus to stabilise in 2H 2012, as slower milk supply growth brought additional milk supplies in line with the local market requirement.

Given that our forecasts for US consumption growth are unchanged for 2H, flat US production will now see the US reduce net exports in 2H 2012. Combined with our existing June forecast for all other regions, that would bring the total volume of milk available for export in the Big 7 export regions in 2H 2012 in line with the prior year.

Such a shift in market fundamentals will clearly impact world prices. At the very least, the case for the recovery in world prices which we outlined in the June GDQ is now much stronger. But more realistically, assuming all else unchanged since the June GDQ, the sensible conclusion is that the recovery in world prices we had anticipated is going to come earlier than expected. This would bring a Q4 rally into contention, making the strength of the coming New Zealand production season—which peaks in Q4—even more influential.

In the US, a significant improvement in international prices is required to ensure that the pricing of milk futures through 2H is achievable. As such, any improvement in US margins beyond those currently on offer on the Chicago Mercantile Exchange (CME) will likely be at best marginal, and will almost certainly come too late to avoid milk production growth stalling in the coming months.