Macroeconomics

The global economy is still focusing on developments taking place in the USA. The decision of the European Central Bank to leave interest rates unchanged had been widely anticipated and the only remaining speculation now is whether we can expect an interest rate hike of 0.25% in June. And, since this has already been factored into the calculations, this would come as no surprise to anyone.

However, concerns about the US economy are slowly but surely rising. The word inflation is starting to be used more frequently and, despite reasonably positive figures from the labour market, most of the economic data being released has been interpreted negatively. There is more caution about the housing market, consumer confidence has fallen and, although March retail figures were still good, they were not good enough as far as the financial community was concerned. American consumers lost confidence in April for the third consecutive month and the University of Michigan's preliminary index of sentiment declined to an eight-month low of 85.3 in April compared with 88.4 in March.

Rising gas and food prices are hitting family budgets hard and the fear of inflation is increasing fairly rapidly. According to the same University of Michigan poll, consumers in the US expect inflation to reach 3-3.3% for 2007. They could be right if energy and raw material prices stay as high as they are at present.

The currency market is more concerned about the risk of an economic slowdown than the problem of inflation and this has been sending the value of the $ sharply lower. Expecting interest rates in the USA to fall, while they rise in the euro zone, and still speculating on a weaker Yen, the value of the greenback continues its downward spiral. With no sign from the Europeans that they are in any way uncomfortable with the rising value of the €, dealers continue to find little risk betting on a falling $ and selling it or using carry trades to borrow cheap Yen or Swiss Francs to invest them into higher yielding currencies.

As easy it may look to make money in a system which could be called ‘perpetuum mobile’—if it works forever—such a system has not yet been invented. When the global liquidity bubble bursts, and this should be the case with rising global inflation, the party will be over. However, this could still take a while and it is still likely that there will be a few obstacles on the way.

In our opinion, the most significant problem continues to be the situation in the USA, with inflation on its way on the one side and indications that the US economy is slowing down on the other. So, there is one reason to lower interest rates and another to move interest rates higher. So far, most of those in charge are still trying to talk the US economy into better shape and imply that the slowdown is simply a correction. Many believe that the Fed will try to stimulate the economy by lowering interest rates rather than combating inflation with higher rates, and the policy of feeding the economy with cheap money when things are problematical has become quite popular. However, there is one big difference in our opinion: although the cost saving effect of globalisation has kept inflation under control for many years, we are not so sure if this is still the case.

Meanwhile, the general global economy is still performing well and the G8  is forecasting a 5% growth for 2007. With the emerging markets still showing higher than average growth and the ‘old economies’ lower than average, the burden is now spread over broader shoulders and wealth is starting to spread more evenly around the globe. This is a beginning at least.

Market intelligence

The leather pipeline is, as we expected, in slow gear after APLF in Hong Kong. As usual, April and May, or the second quarter, is always a period where the dynamic of the business slows down. This seems to be more of a psychological matter rather than being based on a rational explanation. Better weather with the summer break approaching and seasonal changes in the shoe industry could be behind the slowdown in market activity around this time of year.

As far as leather business is concerned, not much has changed. It seems, however, that the seasonal changes have taken a bit of the speed and dynamic from the market leader, the shoe industry. Most of the slowdown is coming from this sector and in Europe the warmer winter has been blamed for this. There are a number of reports that winter shoes (ladies boots) in particular have not sold well this year and that both wholesale and retail stocks have not been cleared. There have also been suggestions of payment delays and tanners being hit by late payment or non-payment, which has not helped to create much enthusiasm.

Positive period for bags and leathergoods

At the same time, tanners of high fashion bags and leather goods are happier and are reporting positive interest as well as decent order books for the coming season. With the results and forecasts coming from the larger luxury brands, this comes as no surprise and, by travelling to shopping centres around the world these days, one can see that luxury leather fashion is still a strong performer.

The signals are somewhat mixed for upholstery. While in Europe, and particularly Italy, the mood is not at its best and tanners are concerned about the end of the season and the decline of the $, the reports from Asia, and more specifically China, are much better. We had not been feeling too positive about the situation, but most of our sources are reporting much higher interest for upholstery-related hides than one would have expected. This could be related to the longer lead times—tanners already have to secure raw materials now for production in order to meet post-summer delivery times—but is also because of the favourable performance of the Chinese domestic market.

Trouble ahead for Brazilian suppliers

In summary, one can certainly say that the leather pipeline overall is less excited and the raw material supply issue is no longer as daunting as it was some weeks ago. We mentioned in one of our previous reports how statistics have shown that the US market was already overdone at the end of 2006 and that buyers had shifted their purchasing needs to other origins, such as Brazil, which had helped to lift prices to the levels we are seeing now.

This leading South American supply source could now be where the US suppliers were six month ago - in a heavily oversold position and under the impression that nothing can break demand. However, from what we are hearing at the moment, it will not be long before US suppliers are forced to give in and the US market is corrected by a few dollars which will shift the interest back to the most favoured supply base. Therefore, the Brazilians could be about to enter a period where they have to prepare for another price correction.

Judging by the price levels paid and quoted for Brazilian hides, one does not need to be too clever to figure out that the hides are overpaid and that there are a number of alternatives at present that would be more cost-effective. The question is whether there is still an excess demand in the market which could keep the expensive hides steady and push the cheaper hides to higher market levels.

Concerns over currency effects and declining demand

Despite the generally strong demand for leather, the positive performance of the global economy and consumer demand in the emerging markets, a certain cap on leather prices was already starting to show last year and this has not been broken or raised recently although leather prices have climbed a bit in the most recent negotiations. However, this increase in price has only just, or perhaps not quite, balanced the 2006 increases in raw material and production costs, and has not allowed for further advances in raw material prices.

If the logic behind our assessment is correct, we have only one solution for the short term development in prices and this could be referred to as further correction mood or a weaker-to-steady price trend. This could negatively impact the non-$ supply market a bit more as this market also has to combat the forthcoming currency trend and most hide exporting currencies have already risen against the $ (€ +12% in a year, Australian $ +7%, NZ$ +8%, SAR +10%) and it still remains uncertain what will to happen to the greenback in the near future. Apart from the currency trend we also have to guess about general demand and, in our opinion, we will see a moderate slowdown in raw material demand over the coming weeks which could support tanners’ attempts to bring raw material prices back to more profitable levels.

The kill continues to be a question mark in this equation. Under normal circumstances, the kill should seasonally increase in the US, remain steady in the Southern hemisphere and decline in Europe into the summer. This pattern for the global kill normally leads to a net increase of supply into the summer and only in Europe can supply bottlenecks in isolated grades be expected. If this general scenario does not take place and, for various reasons the supply does not climb to normal levels, the supply could remain the driving force and support the raw material market in the second quarter. However, we believe the likelihood of this to be below 50%.

Price corrections inevitable

We are forced to disappoint those who have concluded that their chance for a major market downturn has already come. We believe there will be a correction phase where the markets will return to a more balanced situation after the imbalances seen in the second half of 2006 and, in some cases, into early 2007. Some of the corrections have already taken place and, when we talk to our regular and reliable raw material sources from Europe and the USA, many of them are already admitting that the vast majority of their 3%-5% product range price reductions have already taken place over the past four to six weeks and only a very limited number of hide types have been able to hold their positions.

So the need for adjustments is not equal across all categories and can vary form 0% to as much as 10% before the balance of price, value and profitability is achieved again.

The splits market continues to suffer and there is no strong impulse that could really move the market or improve conditions. If there are some new ideas for splits at Lineapelle in Bologna, this could offer some hope but, at the moment, the situation is not too positive.

Good news for lower priced skins

The skins market is a bit mixed. The high price double face lambs continue to suffer and are undergoing a correction. They had been pushed to levels which had been created mainly as a result of speculation and general enthusiasm rather than as a reflection of market realities. They have still not found serious market levels and it is anybody’s guess where they will be, so all kinds of prices are swirling around the markets. Lower priced skins of all kinds are still finding homes at steady or even slowly advancing prices. Buyers’ favourites, particularly in China and the Middle East, are skins that offer a good wool return as wool demand remains fairly high and the returns for fellmongered wool are already paying for a good part of the skins’ price.

We do not predict any change in the phase of general adjustment of raw material prices in the coming weeks. Buyers are starting to gain the upper hand a bit more in the market and, for the time being, sellers can no longer choose from a number of buyers queuing up for the same offer. As we have already explained, everyone has to analyse their own raw material needs and individual position, but for the moment the upward trend has stopped and the downward correction is in place. We believe that the correction potential is still between 0%-5% for the short term, depending on the material.