IN THIS WEEK’S BOTTOM LINE
- It is official. The South African economy is in recession, its first recession since 2009. A recession is defined as two consecutive quarters of GDP contraction. Not only did GDP contract in the second quarter (Q2) by 0.7% quarter-on-quarter annualised but the estimated 2.2% annualised contraction in Q1 was downwardly revised to an even worse 2.6% contraction.
SOUTH AFRICA ECONOMIC REVIEW
- The Standard Bank Financial Conditions Index declined from -0.3 in June to -0.6 in July, the sharpest decline since June 2017, signalling a tightening in financial conditions. The index, which serves as a leading economic indicator, suggests activity will remain lacklustre over coming months. The sharp decline is attributed to a combination of rand volatility, weak domestic capital markets, rising oil prices, slow house price growth and depressed credit extension. Although showing slim gains in nominal terms, the JSE, house prices and credit extension have barely budged in real terms, after taking inflation into account.
- The Standard Bank economy-wide purchasing managers’ index (PMI) fell in July from 49.3 to 47.2 its lowest since April 2016 and well below the key 50-level which demarcates expansion from contraction. Among the PMI sub-indices, the output index fell from 48.8 to 44.4, while the forward-looking new orders and new export orders indices fell from 49.2 to 45.3 and from 48.8 to 47.7, respectively, suggesting little relief in the near-term. At the same time, inflationary indicators increased, the input cost index rising from 52.8 to 58.2 reflecting the impact of rising oil prices and the sharply weaker rand. The output price index increased to 56.3, its highest since July 2016, confirming that higher costs are being passed-on rather than absorbed. The Standard Bank PMI mirrored a similar sharp drop in the BER manufacturing PMI, reported last week, confirming a high degree of economic uncertainty and weak activity.
- South Africa’s current account deficit narrowed in the second quarter (Q2) to an annualised 3.3% of GDP. While still high by emerging market standards, this marks a substantial improvement on the 4.6% deficit recorded in Q1. In addition, the deficit in Q1 was revised lower from an initial 4.8% and in Q4 last year from 2.8% to 2.6%. The improvement in Q2 is attributed to a better trade performance amid rising exports and slow import demand. The goods trade balance showed an annualised surplus in Q2 of 0.7% of GDP compared with a deficit of 0.3% in Q1. The shrinking current account deficit reduces South Africa’s external financing needs and is therefore moderately positive for the rand.
- In an interview with the Financial Times, Reserve Bank Governor Lesetja Kganyago stressed that South Africa should not be placed in the same category as Turkey and Argentina, which have been hit the hardest in the current emerging market sell-off. Referring to the independence of South Africa’s monetary policy he said: “Institutions matter. That is why we are not a Turkey, or an Argentina – or a Venezuela for that matter.” Kganyago also observed that compared with other emerging markets South Africa had less foreigncurrency debt. His remarks mirror those by S&P Global Ratings, which last week pointed out that: “In stark contrast to Turkey, South Africa is a net external creditor, and this creditor position benefits from rand depreciation.”
SOUTH AFRICA: THE WEEK AHEAD
- Manufacturing production: Due Tuesday 11th September. According to consensus forecast manufacturing production is expected to have increased in July by 0.85% year-on-year, a slight uplift from 0.7% the previous month. The modest improvement is predicted by the July manufacturing purchasing managers’ index, which before tumbling in August had recovered the key 50-level, which demarcates expansion from contraction.
- SACCI Business Confidence Index: Due Wednesday 12th September. The SACCI Business Confidence Index, which surged higher in January to its highest since October 2015, has been on a downward slide ever since due to political and policy uncertainty. The decline is expected to have extended in August from 94.7 to 91.5 according to consensus forecast.
- Retail sales: Due Wednesday 12th September. While retail sales remain constrained by the recent increase in VAT, rising inflation and a depressed labour market, the resolution of public sector wage negotiations will have brought some relief to consumer spending. According to consensus forecast, retail sales growth is expected to have nudged higher in July to 1.55% year-on-year from 0.70% in June.
- RMB/BER Business Confidence Index: Due Thursday 13th September. Having slumped in the second quarter (Q2) from 45 to 39 the RMB/BER Business Confidence Index is likely to have lost further ground in Q3, damaged by uncertainty over land expropriation, lacklustre domestic demand and the threat of a burgeoning global trade war.
- Mining production: Due Thursday 13th September. According to consensus forecast, the mining sector, which contributed positively to GDP output in the second quarter (Q2), is expected to have increased output in July by 2.95% year-on-year, matching its June figure of 2.85%. The sector however, is still not running at its full potential due to ongoing uncertainty over mining legislation.
- Public comment closed last week on the next raft of US trade tariffs on China, to be levied on an additional $200 billion worth of annual trade. The US administration is debating whether to implement the tariffs in one go or on a staggered basis and at what rate, whether at 25% or a softer 10% as has been suggested for consumer-sensitive goods. Meanwhile president Trump announced: “I hate to say this, but behind that there is another $267 billion ready to go on short notice if I want.” This would take the total amount of imported goods from China subjected to import tariffs to over $500 billion. The trade dispute is likely to escalate over the next two months until the conclusion of the US midterm elections in the second week of November. The main sticking point as far as China is concerned are US demands for deep structural changes to the country’s industrial policy.
- The Markit global manufacturing purchasing managers’ index (PMI) fell in August from 52.8 to 52.5 its lowest since December 2016. Although declining steadily since the start of the year, the PMI remains comfortably above the expansionary 50-level and is consistent with global GDP growth of around 4.0%, which is high by historic standards. Among the major regions, the US PMI showed a surprising upturn despite a difficult trading environment and a strengthening dollar while China’s PMI continued its downward trend. However, the outlook for both regions could be considerably different in a year’s time. China has adopted mild fiscal and monetary policy easing which will eventually provide support to the economy. On the other hand, the US economy is likely to slow sharply over the next two years as the tax stimulus fades. The OECD composite leading indicator, which signals economic turning points 6-9 months ahead, signals an easing in growth momentum in the OECD, which may continue into 2019 but at that stage an offsetting acceleration in China and India.
- Non-farm payrolls increased in August by 201,000 up from a downwardly revised 147,000 in July. Over the past three months the payroll figure has averaged 185,000 slightly above the 2017 monthly average of 182,000. Despite the payroll growth the unemployment rate remained unchanged at 3.9% although the wider U6 measure of unemployment, which includes Americans stuck in part-time jobs or too discouraged to look for work, fell from 7.5% to 7.4%. Wage growth was the highlight of the employment report. Average hourly earnings increased 0.4% month-on-month lifting annual wage growth from 2.7% to 2.9% year-on-year, the highest since mid-2009. Wages are typically a precursor to higher inflation. Together with consumer price inflation, which is at its highest in several years, the wage data will reinforce the Fed’s commitment to quarterly 25 basis-point interest rate hikes. Fed funds futures predict a 99.8% probability of a rate hike at the next policy meeting on 25-26 September. The probability of a rate hike at the following meeting in December increased from 70.9% to 74.3% following the wage data.
- Eric Rosengren, president of the Federal Reserve Bank of Boston, argued that the Fed should continue raising interest rates at its current quarterly pace over the next year, which would indicate four rate hikes of 25 basis-points each. Discussing the neutral interest rate, which neither stimulates nor restricts growth, Rosengren said: “It’s certainly higher than where we are now and is likely to be maybe a percentage point higher.” At that point, Rosengren suggested that the Fed, depending on economic conditions, may lift the fed funds rate beyond the neutral rate to deliberately slow growth and prevent the economy from overheating. In contrast to Rosengren, Federal Reserve Bank of St. Louis President James Bullard, known for being more “dovish” than his Fed colleagues and more reticent about monetary tightening, cited the flattening yield curve. The yield curve measures the difference between short- and long-dated interest rates (yields). Bullard said: “I’d rather not see an inverted yield curve in the US. That’s usually a harbinger of a slowdown ahead.”
- The US trade deficit surged in July from $45.7 billion to $50.1 billion its highest since February. US exports sank by 1.0% month-on-month largely attributed to a 16% decline in soybean exports following the imposition of Chinese trade tariffs. At the same time imports increased by 0.9% to a monthly record as Americans purchased more capital goods from abroad. Ironically, president Trump who is determined to fix the US trade imbalance is exacerbating it through his expansionary fiscal policy. Goods imported from China increased in July by 1.6% on the month while exports to China fell sharply by over 8%, causing the bilateral trade deficit to widen from $32.5 billion to $34.1 billion. The widening trade deficit suggests the boost to GDP growth in the second quarter (Q2) from net exports will be reversed in Q3. If extrapolated into August and September, the trade deficit may shave a full percentage point from Q3 GDP growth.
- The Institute for Supply Management (ISM) manufacturing index unexpectedly surged in August from 58.1 to 61.3 its highest since May 2004 and well above the consensus forecast of 57.6. Among the ISM sub-indices, the production index gained from 58.5 to 63.3 and forward-looking new orders index from 60.2 to 65.1. However, the new export orders index slipped from 55.3 to 55.2 attributed to slowing external demand, the effect of US trade protectionism and the negative impact of the strengthening dollar. The dollar index has strengthened by around 8% over the past five months. Timothy Fiore, chairman of the ISM manufacturing business survey committee observed that: “Demand is still robust, but the nation’s employment resources and supply chains continue to struggle. Respondents are again overwhelmingly concerned about tariff-related activity.” While the latest ISM data is consistent with manufacturing output of around 5% annualised in the third quarter (Q3), the stronger dollar and growing trade constraints are likely to prompt a slowdown in Q4.
- Consumer price inflation (CPI) increased in August by an elevated 0.7% month-on-month, its highest since February’s 1.2% gain when the Chinese New Year boosted widespread price growth. The gain is attributed to sharply higher food prices. The swine flu caused pork prices to jump 6.5% on the month. On a year-on-year basis CPI jumped in August from 2.1% to 2.3%. Food prices were a key driver, rising from 0.5% to 1.7% while gasoline prices increased 19.8% on the year. Core CPI, excluding food and energy prices, was more subdued although it also picked-up from 1.9% to 2.0%. Meanwhile, producer price inflation (PPI) slowed on a year-on-year basis from 4.6% to 4.1% indicating a lack of pipeline inflationary pressure. While CPI increased in August to multi-month highs the broader outlook for inflation remains benign paving the way for the People’s Bank of China to continue easing monetary policy.
- Growth in total labour cash earnings slipped in July from 3.3% year-on-year to 1.5% although remained positive for the 12th straight month. The slowdown is attributed to a decline in bonus payments, which are notoriously volatile. Although bonus payments grew by 2.4% on the year, this marks a sharp decline from 6.3% in June and 18.2% in May. Nonetheless summer bonus payments, across June and July combined, increased by a robust 4.8% on the year, the strongest gain since 1991 amid a surge in company profits. Moreover, base pay, which excludes bonuses, increased by a solid 1.0% on the year, marking the 16th straight annual gain. Higher wages are the key prerequisite for higher inflation. Wages are expected to strengthen further with unemployment at just 2.5%, its lowest since the early 1990s, although perhaps not enough to achieve the Bank of Japan’s 2% inflation target.
- Second quarter (Q2) GDP growth was revised sharply higher from 0.5% quarter-on-quarter to 0.7% and from an annualised rate of 1.9% to 3.0% its fastest pace since hitting 3.4% in Q1 2016. The upward revision is attributed to stronger than expected growth in domestic demand which in quarter-on-quarter terms was upgraded from 0.6% to 0.9%, due almost entirely to stronger business investment. Business investment grew a massive 3.1% on the quarter up from the initial 1.3% estimate. Businesses are increasing investment amid severe capacity constraints. The ratio of non-residential investment to output is at its highest in almost 30 years. Continued investment spending bodes well for GDP growth in the second half of the year and domestic demand generally is likely to accelerate ahead of the scheduled sales tax increase in 2019. Meanwhile, although industrial production fell in July for the third straight month firms are forecasting a 5.6% month-on-month increase in August. EUROPE
- Growth in Eurozone retail sales slipped in July from 1.5% year-on-year to 1.1% while monthon-month growth turned negative from 0.3% to -0.2%. However, most of the decline is attributed to a sharp 0.7% month-on-month decline in fuel sales, attributed to steep price increases. Furthermore, food, drink and tobacco sales fell 0.6% on the month. Retail sales of non-food products increased 0.4% on the month reversing the previous month’s 0.2% contraction. Despite the slowdown in overall retail sales in July the outlook for consumer spending remains positive amid ongoing employment growth and tame inflation. The European Commission’s retail sentiment index lifted in August to its highest level since February.
- Germany’s factory orders unexpectedly fell in July by 0.9% month-on-month following-on from the steep 3.9% decline in June. According to consensus forecast a 1.8% increase had been expected. While Germany’s domestic factory orders grew 2.4% on the month, foreign orders fell sharply by 3.4%. Eurozone orders fell 2.7% and non-Eurozone orders by a substantial 4.0% indicating that trade uncertainties are starting to have a major impact. Mirroring the weakness in factory orders, Germany’s industrial production fell in July by 1.1% on the month steepening from June’s 0.7% decline. Construction output increased by 2.6% its strongest pace in 17 months, which helped prop-up the aggregate number. Core industrial production, excluding traditionally volatile energy and construction sectors, fell by a substantial 1.9% on the month. While the latest data may be disappointing, industrial production is expected to recover over coming months according to the forward-looking components of the August manufacturing purchasing managers’ index.
- Italy’s 10-year government bond yield fell below the psychologically-important 3.0% level for the first time since mid-August amid reassurances from the government’s populist coalition partners that it would abide by EU budget rules. The bond yield spiked up to 3.4% in May following government pledges to flout EU fiscal constraints with a spending binge and tax cuts. The latest assurances that Italy will aim for structural improvements, reduce public debt and keep the budget deficit within the mandated 2% of GDP, have helped to reassure capital markets. Eurozone governments are required to submit their draft budget proposals to the EU by 15th October.
- Switzerland’s GDP grew in the second quarter (Q2) by a stronger than expected 0.7% quarter-on-quarter while Q1 growth was revised upwards to 1.0%. On an annualised basis GDP grew in Q2 by a substantial 3.4%, up strongly from the 1.6% growth achieved in 2017. Ronald Indegrand, a government economist responsible for forecasting, observed that: “For the year as a whole we could be looking at a growth rate much nearer to the 3 percent rate than 2 percent, which would be above the long-term average.” Although solid growth momentum suggests the Swiss National Bank (SNB), which cut its benchmark interest rate to -0.75% in January 2015, will be keen to normalise monetary policy any change in rates is likely to hinge on the ECB. The SNB’s decision to introduce negative interest rates was motivated primarily by a desire to limit the appreciation of the Swiss franc versus the Euro.
- GDP grew in July by a stronger than expected 0.3% month-on-month, lifting the rolling 3- month-on-3-month growth rate from 0.4% to 0.6% its fastest pace since February 2017. The data supports the view from the Bank of England that the slowdown at the start of the year was weather related and likely to reverse. On a rolling 3-month basis, the construction sector grew by a solid 3.3% with builders catching up on weather related backlogs. The service sector remained the stalwart of the economy, rising output on a rolling basis by 0.6% up from 0.5%. The manufacturing sector, while not contributing to growth was no longer a drag on GDP, with output flat on a rolling basis compared with a contraction of 0.9% the previous month. The overall data suggests that in the run-up to the crucial phase of the Brexit talks the UK economy is in better shape than previously thought.
- The Markit purchasing managers’ index (PMI), measuring performance of the service sector of the economy, increased in August from 53.5 to 54.3 well above the key 50-level which demarcates expansion from contraction. Encouragingly, the forward-looking new orders index increased from 53.2 to 54.0 suggesting the service sector will maintain positive momentum in coming months. The PMI is consistent with quarter-on-quarter growth in service sector output of around 0.5%, matching the solid pace recorded in Q2 and providing reassurance that economic growth will maintain positive momentum into the third quarter.
FAR EAST AND EMERGING MARKETS
- Markit’s emerging market manufacturing purchasing managers’ index (PMI) fell in August from 51.0 to 50.8 its lowest since June 2017. The decline was broad-based across emerging markets although especially pronounced in emerging Europe due mainly to the slowdown in Turkey. The PMI data reveal rising inflationary pressure across emerging markets, although this may be due to sharp currency declines and therefore supply-led rather than demandpull inflation. Encouragingly, the decline in the new export orders component of the PMI data appears to have steadied, indicating a stabilisation in emerging market export volumes.
- At the triennial Forum on China-Africa Co-operation, attended in Beijing by representatives from 54 African countries, China’s President Xi Jinping pledged $60 billion in financial aid to Africa. The financial aid would comprise a combination of grants, low-interest loans, financial investment and trade finance. Addressing growing accusations that China is embarked on a programme of debt diplomacy, President Xi said: “Only Chinese and African people have a say when judging if the cooperation is good or not between China and Africa. No one should malign it based on imagination or assumptions.” He announced that China would offer debt relief to the poorest nations. According to the China Africa Research Initiative at Johns Hopkins University, China is providing official concessional assistance to Africa of $5 billion per year, the highest on record.
KEY MARKET INDICATORS (YEAR TO DATE %)
JSE All Share - 4.69
JSE Fini 15 - 7.37
JSE Indi 25 - 8.90
JSE Resi 20 + 16.99
R/$ - 18.55
R/€ - 15.62
R/£ - 15.41
S&P 500 + 7.61
Nikkei - 1.72
Hang Seng - 11.05
FTSE 100 - 5.31
DAX - 7.21
CAC 40 - 0.81
MSCI Emerging - 12.71
MSCI World + 1.86
Gold - 7.80
Platinum - 15.76
Brent oil + 16.30
- The rand has retraced 50% of its 2016-2017 appreciation against the US dollar, indicating that the spike in the rand/dollar rate to R/$15.50 in the first week of September may mark the peak in the currency’s recent decline.
- The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
- The British pound has broken back below key resistance at £/$1.35 suggesting a trading range of £/$1.30-1.35. The £/$1.28 level is expected to provide strong resistance.
- The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
- The US 10-year Treasury yield is struggling to break decisively above key resistance at 3.0%. However, a break above this level is expected and would open the next target of 3.6%.
- The benchmark R186 2025 SA Gilt yield has retraced earlier weakness and fallen back below the key 9.0% level. A trading range of 8.4-9.0% is expected over the foreseeable future.
- Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
- The Brent oil price has struggled to break above key resistance at $75 per barrel, indicating a likely trading range of $65-75 per barrel. The outlook for base metals prices is less certain after the copper price retreated sharply from the key $7000 per ton level. A decisive break below $6000 per ton would herald a bear market in copper and base metals’ prices.
- Gold has developed an inverse “head and shoulders” pattern, which indicates a price recovery and a test of the $1400 target level.
- Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56,000 and 60,000 in December signals the early stages of a new bull market.
- It is official. The South African economy is in recession, the country’s first recession since 2009. A recession is defined as two consecutive quarters of GDP contraction. Not only did GDP contract in the second quarter (Q2) by 0.7% quarter-on-quarter annualised but the estimated 2.2% annualised contraction in Q1 was downwardly revised to an even worse 2.6% contraction.
- What has happened to President Ramaphosa’s “New Dawn”. Has it been extinguished before it could even get started or has it merely been postponed by a couple of quarters? We believe the latter scenario. Although clearly disappointing (the consensus forecast was for annualised GDP growth of 0.6% in Q2), it is a very shallow recession and not one that is likely to persist into Q3.
- The GDP contraction was not as bad as indicated in the headline number. On a year-on-year basis GDP managed growth of 0.5% in Q2 and 1.5% ibn Q1. If agriculture, extremely volatile at the best of times, is stripped out, annualised GDP would have increased by a slender 0.1% in Q2. Output from agriculture, forestry and fishing fell in Q2 by an annualised 29.2% and in Q1 by 33.6%. By contrast the sector grew in Q3 and Q4 last year by 41.7% and 39.0%. The volatility of agricultural output suggests that the sector is quite likely to rebound in the second half of the year, reversing the negative effect it has had on GDP in the first half.
- The expenditure breakdown of GDP reveals an outsized negative impact from a rundown in inventories. The massive R14 billion reduction in inventories detracted a full 2.9 percentage points from annualised Q2 GDP growth. Depleted inventories eventually need restocking, which bodes well for a boost to GDP growth over coming quarters.
- On the expenditure side, exports performed extremely well, contributing 3.7 percentage points to annualised Q2 GDP growth. Exports increased in Q2 by 13.7% quarter-on-quarter while imports increased by just 3.1%. The sharp depreciation in the rand since the start of Q3 will have greatly enhanced South Africa’s terms of trade and the competitiveness of its exports, boosting the likelihood of an even stronger export contribution to GDP growth in the second half of the year. Since the 30th June the rand has dropped by over 12% against the US dollar.
- Encouragingly on the supply-side breakdown of GDP, mining output grew in Q2 by 4.9% annualised a sharp improvement from the 10.3% contraction in Q1. Construction output grew for the first time in five quarters, rising 2.3% compared with a 1.9% contraction in Q1. Manufacturing shrank by 0.3% annualised but this is much better than the 6.7% contraction in Q1. Finance, real estate and business services grew output by 1.9% up from 1.1% in Q1.
- Bright notes on the expenditure side include a more moderate contraction in gross fixed capital formation (GFCF) from 3.4% in Q1 to 0.5% in Q2. In addition to the stabilisation in aggregate gross fixed capital formation (GFCF), the composition of GFCF also improved, showing a moderation in government spending, which displays fiscal prudence, and a rebound in private sector spending. Private sector spending grew by 3.1% compared with a 3.9% slump in Q1 while government spending fell 10.1% accelerating from the 3.6% fall in Q1.
- Household expenditure was a soft patch with an annualised decline of 1.3% in Q2 compared with 1.0% growth in Q1. Household expenditure contributes around 60% of the expenditure side of South Africa’s GDP and therefore subtracted a substantial 0.8% percentage points from annualised Q2 GDP growth. A silver lining in the GDP numbers is that interest rates are unlikely to rise for the foreseeable future. A lack of domestic demand pressure, especially at household level, should ensure that the weaker rand has limited pass-through to higher inflation.
- GDP growth is likely to rebound in the second half of the year. The powerful detractions from agriculture output and inventory drawdowns are expected to reverse, while the sharply weaker rand will support an even stronger contribution from export performance. However, beyond the expected rebound in the second half of the year, a sustainable uptrend in GDP growth will depend on greater political and policy certainty and meaningful supply-side economic reforms.
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