Coffee economics

Currencies and coffee – an undeniable correlation

Currency devaluations across the world have been a feature for the coffee market in recent months, and indeed for the broad commodity spectrum. A weakening local currency against the US dollar means a higher local coffee price, the near-term bearish impact being increased selling and exports and the long-term bearish impact the potential for increased focus on boosting production. Much depends on what percentage of producers’ inputs are dollar-denominated costs, as fertilisers are more expensive with devaluation in local currency terms if they are dollar-denominated. Coffee trade is a major source of foreign currency (US dollars) for origin countries, and while the degree to which coffee contributes to this is lower than it was 50 years ago, some nations still depend heavily on the contribution from coffee trade. The higher the share of production, the larger the impact of currency volatility on the global coffee price, an outstanding example being the selling pressure from Brazil in 2015. The correlation between the Brazilian real/US dollar and Arabica prices has increased over the past 10 years or so. While there are clearly out-and-out Arabica fundamentals of supply and demand in play, it is fair to say nowadays that a weaker Brazilian real has a stronger correlation with a weaker ICE Arabica price. Expectations are that the currency situation in Brazil will continue to be a pressure factor for ICE Arabica, particularly when 2015/16 supply is not expected to be as hard hit as had been projected at the start of 2015. As July 2015 progressed, the Brazilian real posted further losses, and is at levels 17 per cent lower than at the beginning of the calendar year. Forecasts are that the currency could be another 1 per cent lower at least by the end of 2015. Recent losses have been compounded now by concerns that President Dilma Rousseff is less committed to maintaining the nation’s credit rating. Rousseff has decided to lower this year’s budget surplus target before interest payments to 0.15 per cent of GDP from 1.1 per cent, which increases the risk of rating agencies downgrading the country.  In contrast, Vietnam tends to hold back coffee at times of currency volatility, as a hedge or liquid asset, and moreover there has been increased competitiveness from Indonesia in recent months given that its rupiah currency has devalued more than the Vietnamese dong. Note also that Vietnam has low interest rates and storage options that help sellers hold on to coffee until they are happy with the price that they would receive. Vietnam devalued its dong in May 2015 for the second time in 2015, cutting the average rate by 1 per cent from 21,458 per US dollar to 21,673. The currency was also weakened in January by 1 per cent. Ho Chi Minh based traders highlight that on the input front, a weaker Vietnamese dong means that these are more costly in dollar terms, but the depreciation in currency has been limited enough that there has been little impact in the current era when fertiliser use is much less than it was at the time when Vietnam burst onto the world coffee stage. Vietnamese trade has been limited in the past few months, to the advantage of Indonesia in the past few weeks. One factor, as mentioneda bove, is that the rupiah has weakened more than the dong against the US dollar. A weak rupiah currency was a key driver in boosting Indonesian robusta exports to Europe in June, with shipments from the top growing locality of Sumatra rising by over 20 per cent. The increase is not entirely due to currency, but also to increased production from the new 2015/16 crop, but a continued weak rupiah is expected to bolster exports in July/August too. It depends at what level the Vietnamese decide they are losing out to Indonesia, and begin selling their supply. Indonesia’s rupiah is the second worst performing currency in emerging Asia (worst is Malaysian ringgit) so far in 2015, depreciating by almost 8 per cent  since the start of 2015, and expectations are that it will weaken further by the end of the calendar year because of Indonesia’s current account deficit and slowing economic growth. In July, Bank Indonesia revised its forecast for national economic growth in 2015 down from 5.0-5.4 per cent  to 5.0-5.2 per cent. Indonesia’s 2014 economic growth fell to its weakest in five years amid weak exports and investments. GDP expanded at 5.02 per cent in 2014 compared with 5.58 per cent in 2013. Looking at the last of the world’s top four coffee producing countries, the Colombian peso is at its lowest in a decade against the US dollar. The peso is around 2800 against the US dollar as opposed to 2200 at the start of 2015, and in previous years 1800-1900 when the country was enjoying an investment boom, especially in oil. Note that oil accounts for 50 per cent  of foreign earnings in Colombia, and the decline in crude prices has been a factor in the weaker Colombian peso. The weakening peso has added selling pressure at a time when Colombian production has been recovering from its extremely low 2008/09 crop. Given that these four producing countries account for almost 100 million bags of a total global crop of nearly 150 million bags in 2014/15, the impact of their currency movements is a substantial factor for the world coffee market. The downwards pressure on global coffee futures prices is undeniable.  On differentials, if the continuing emerging market currency devaluations continue apace, and the market can find some short term support, differentials are expected to weaken as well as internal market prices in producing countries will increase across the board, thereby lowering differentials. GCR
Disclaimer: comments in this article should be construed as market commentary and not as market trading advice.

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