• Financial and commodity markets in a state of cautious optimism, but private sector weakness and austerity programs continue to weigh on economic activity
• Dairy prices to strengthen on high feed costs, weakening production prospects
• Australian dairy production outlook weaker as a tough winter and spring soften conditions, cash flow also becoming a concern

As expected, the initial euphoria of central bank monetary easing measures announced through September and early October is beginning to wane. Broadly speaking, central bank actions have managed to avoid the worst thereby taking some of the tail risk out of financial and commodity markets.
However, ongoing weakness in private sector demand, coupled with programmes of fiscal austerity continue to weigh on economic activity, meaning markets do remain cautious. Nonetheless, risk assets have clearly become less volatile over the past couple of months and this is being reflected in the VIX Index – which has been tracking at fairly low levels by post financial crisis standards.

Providing a sizeable degree of support to commodity markets over recent weeks has been a promising run of economic data coming out of Asia. China’s manufacturing sector is improving and recent indicators suggest that this should continue over the near-term. Similarly, South Korea appears to be emerging from its soft patch with industrial production partly unwinding three consecutive months of decline while Taiwanese production and exports appear to have lifted from its mid-year sluggishness. In contrast, the Japanese economy continues to under-perform as political tensions with China and weak demand from trading partners continues to weigh on Japanese activity.

In the US, we have started to see some encouraging signs for the economy with residential dwelling investment looking positive while signs are emerging of a slowing in household balance sheet repair. However, the recovery does remain quite tepid and confidence is still lacking. However, despite the slowly emerging positive sings, the threat of an impending fiscal cliff have kept markets on edge. Under a worse case scenario, the scheduled spending cuts and tax hikes could amount to 5 per cent of GDP. However, given the economic ramifications, we doubt that policy makers would allow the economy to walk off the edge of the cliff. As such, we think an 11th hour deal likely although we can expect to see increased volatility in markets in the lead-up to the deadline.

For further analysis download the full report.

• NAB Rural Commodities Wrap – November 2012 (PDF 224KB)