IN THIS WEEK’S BOTTOM LINE

  • The SARB traditionally errs on the side of caution, far slower to react than most emerging market central banks to changing external conditions. This is borne out by far fewer interest rate changes. Just as the SARB was slow to respond to the 9% appreciation in the R/$ exchange rate in the month following last December’s ANC elective conference, the response to the current rand slump is likely to be equally measured. The SARB will most likely adjust its accompanying policy statement to reflect a more “hawkish” tone, cautioning against the increased risks of higher inflation. However, a rate increase is extremely unlikely especially with the country in recession.

SOUTH AFRICA ECONOMIC REVIEW

  • The BER Business Confidence Index (BER BCI), which has a direct lagged relationship with gross fixed capital formation, fell from 39 in the second quarter (Q2) to 38 in Q3, having been as high as 45 in Q1, inspired by the inauguration of Cyril Ramaphosa as president. The index remains well below the 50-level, which marks the threshold between net positive and net negative confidence, suggesting investment levels are likely to remain depressed over the next 6-9 months. A turnaround in confidence levels likely depends on greater policy certainty over land reform, mining legislation, and a more efficient public sector. Among the BER BCI sub-categories, confidence levels fell further for manufacturers, wholesalers and retailers but increased marginally for new vehicle dealers and building contractors.
  • The SACCI Business Confidence Index (SACCI BCI), after rising modestly in July from 93.7 to 94.7, slumped in August to 90.5 its weakest since August 2017. Of the 13 sub-components, the biggest negative drivers were a fall in exports, a weaker rand, and higher inflation, while there was a marked improvement in import volumes, construction activity, vehicle sales and real financing costs. The SACCI BCI indicates a lack of economic momentum and jobs growth in the months ahead. Potential catalysts for a change in business sentiment include the decision by the Constitutional Review Committee at the end of September on whether the constitution needs to change to better facilitate land expropriation without compensation. Other potential catalysts in October include upcoming jobs and investment summits and the Medium-Term Budget Policy Statement, which will be closely scrutinised for any slippage in fiscal prudence.
  • Retail sales volumes grew in July by a stronger than expected 1.3% month-on-month more than reversing the 1.1% decline in June and well ahead of the 0.3% consensus forecast. On a year-on-year basis, retail sales increased in July by 1.3% while June’s figure was revised substantially upwards from 0.7% to 1.8%. The data bodes well for a return to GDP growth in the third quarter (Q3). Among the retail sectors, textiles, clothing, footwear and leather goods grew 3.0% on the year up from 1.0% in June. Household furniture, appliances and equipment grew 6.9%, pharmaceuticals and medical goods, cosmetics and toiletries grew 2.1%, while hardware, paint and glass contracted 5.1% the sixth straight year-on-year decline. Retail sales should maintain a modest uptrend over Q3 helped by the public wage settlement and rising household credit extension.
  • Manufacturing production volumes increased in July by a stronger than expected 2.9% yearon-year up from 0.6% in June. Although the figures may have been flattered by there being one more working day in July 2018 than in July 2017, the month-on-month increase of 1.6% was also encouraging, compared with just 0.2% in June. Among the manufacturing sectors, motor vehicles, parts, accessories and other transport equipment increased by a solid 8.3% on the year after contracting 2.8% in June. Food and beverages production, which contributes 25.8% of total manufacturing production, was also strong with growth of 5.8% on the year accelerating from 4.1% in June. Although showing an encouraging start to the third quarter (Q3), manufacturing production is unlikely to maintain momentum over the remainder of Q3 according to survey data. The BER manufacturing confidence index fell in Q3 from 27 to 21 well below the neutral 50-level while the BER manufacturing purchasing managers’ index slumped in August from 51.5 to 43.4 its lowest since August 2017, also well below the key 50-level.
  • Spoiling an otherwise strong start to the third quarter (Q3) from both retail and manufacturing sectors, mining production slumped in July by 8.6% month-on-month more than reversing June’s 5.0% increase. On a year-on-year basis production contracted by 5.2% following an increase of 3.7% in June. The decline was broad-based. Production of copper, nickel, iron ore, gold and building materials fell year-on-year by 42.0%, 22.7%, 17.4%, 15.0% and 9.3%, respectively. Although notoriously volatile, mining production, after contributing positively in Q2, may detract from GDP growth in Q3. The sector continues to perform below potential due to lingering uncertainty over mining legislation.

SOUTH AFRICA: THE WEEK AHEAD

  • Consumer price inflation: Due Wednesday 19th September. According to consensus forecast consumer price inflation (CPI) will have remained in August at July’s level of 5.10% year-onyear despite the falling rand, rising fuel price and lingering effects of the April VAT increase.
  • South African Reserve Bank Monetary Policy Committee meeting: Due Thursday 20th September. No change in interest rates is expected although the South African Reserve Bank Monetary Policy Committee meeting is likely issue a more “hawkish” statement outlining the growing risk of inflation stemming from the sharply weaker rand.

GLOBAL

  • President Trump confirmed that from next week a 10% tariff will be imposed on around $200 billion worth of Chinese imports. He threatened to increase the tariff to 25% in 2019 if no deal is reached to ease trade tensions. Tariffs have now been raised on around half of all Chinese imports. The main sticking point in the trade war are US demands for deep structural changes to China’s industrial policy such as its subsidies to state-owned enterprises (SOEs). Unfortunately, Trump’s aggression may prompt China to strengthen its commitment to “state capitalism”. The muted response in China’s financial markets suggests the latest tariff announcement had already been broadly discounted. On the day of the announcement the yuan fell against the US dollar by just 0.1% well within its permitted 2% daily band, while the CSI 300 index of Shanghai and Shenzen stocks fell by a modest 0.1%. In retaliation, China is likely to restrict sales of materials, equipment and other components which are key to US manufacturers’ supply chains.

NORTH AMERICA

  • Consumer price inflation (CPI) eased in August for the first time this year, dipping from 2.9% year-on-year to 2.7%. Core CPI, more closely monitored by the Fed as it excludes food and energy prices due to their volatility, eased from its decade-high of 2.4% to 2.2%. On a month-on-month basis core CPI increased just 0.1%, its smallest monthly increase since April. Among CPI components, rent gained by 0.4% on the month and used vehicle prices by 0.4%. However, clothing prices fell 1.6% and wireless telephony services by 0.4%. Meanwhile, producer price inflation fell in August from 3.3% year-on-year to 2.8% the first decline in 18 months, reflecting the disinflationary effect of a sharply stronger dollar. While mindful of the dollar’s influence on inflation, continued employment and wage growth, increasing capacity constraints and rising tariffs are likely to keep the Fed on its course of quarterly interest rate hikes.
  • The NFIB Small Business Optimism Index soared in August to its highest level in the survey’s 45-year history. Capital spending plans were the strongest since 2007. According to the NFIB survey, job creation plans and unfilled job openings both set new records confirming a tightening labour market and the prospect of increased wage pressure. A quarter of firms reported labour quality as their biggest constraint. The Job Openings and Labour Turnover Survey (JOLTS) painted a similar picture, reporting a record-high job openings rate. Meanwhile, the Fed Beige Book, an anecdotal summary of regional business conditions, highlighted considerable concern over an increasingly tight labour market exacerbated by a shortage of skilled labour. According to the Beige Book, the lack of available labour has in many cases resulted in projects being halted or delayed.
  • Industrial output increased in August by a solid 0.4% month-on-month marking the third consecutive monthly increase while year-on-year growth accelerated to 4.9% from 4.0% in June. Among the industrial sectors, which include manufacturing, mining and utility output, utility output increased 1.2% on the month boosted by unusually warm weather and extra demand for air-conditioning. Mining production increased 0.7%, unchanged from the previous month. Growth in manufacturing production slowed from 0.3% to 0.2% reflecting the dampening effect of a strengthening dollar on export competitiveness. Moreover, manufacturing numbers were flattered by a 4.0% month-on-month surge in vehicle production reflecting a front-loading of production ahead of seasonal plant retooling. If the vehicle component is excluded, manufacturing production would have shown nil growth on the month.
  • Despite disappointing retail sales figures for August, the University of Michigan consumer confidence index climbed in September to its highest in six months and second highest since 2004, rising from 96.2 to 100.8. The current conditions index increased from 110.3 to 116.1 while the expectations index increased from 87.1 to 91.1 a 14-year high. Consumers cited exceptionally strong labour market conditions, rising equity market prices and relatively stable gasoline prices. Inflation expectations over one and five years also slipped back to 2.8% and 2.4%. A slight majority of respondents expect the current economic expansion to continue over the next five years. However, the trade war was cited as the biggest threat to the economic expansion.
  • Retail sales growth slowed sharply in August to 0.1% month-on-month from 0.7% in July the weakest gain in six months. The main culprits were vehicle sales which fell 0.8% on the month and clothing sales which fell 1.7%. The so-called “control group” sales, excluding vehicles, gasoline and building materials, also increased by just 0.1% on the month. However, July’s increase was revised upwards from 0.5% to 0.8%. The 3-month-on-3-month annualised growth rate remained buoyant at 5.4%, which is consistent with third quarter (Q3) consumer spending growth of around 3.5%, close to the Q2 growth rate of 3.8%. Record high consumer confidence is likely to maintain consumer spending as the main engine of GDP growth in the second half of the year although the fading tax stimulus may cause a sharp slowdown from mid-2019.

CHINA

  • Despite increased policy stimulus, growth in fixed asset investment slowed in the first eight months of the year to 5.3% year-on-year, the lowest since at least 1992 when the data series began and the fifth consecutive record low. Investment slowed in the property, manufacturing and infrastructure sectors although picked-up in agriculture and services. More encouragingly, retail sales growth increased in August by 9.0% on the year up from 8.8% in July while industrial production growth increased from 6.0% to 6.1%. Growth in industrial export sales increased sharply from 8.7% to 12.5%, indicating far stronger export demand than domestic demand although this may change as the trade war intensifies. Domestic demand, although losing momentum, is likely to recover as fiscal and monetary stimulus starts to take effect. Further stimulus measures are likely in the months ahead.

JAPAN

  • Core machinery orders, excluding those for ships and from electric utilities, a closely watched barometer for investment spending, soared in July by 11.0% month-on-month, the first increase in three months and the largest since January 2016. On a year-on-year basis, machinery orders increased 13.9%, indicating strong capital spending in the months ahead. Investment spending should remain a key driver of GDP growth over the foreseeable future. Firms are reporting the largest capacity shortages since the early 1990s while their capital spending plans are the most optimistic since 1990. By industrial sector, orders from the manufacturing sector increased 11.8% and from the non-manufacturing sector by 10.9%. Government orders increased 57.0% due to the procurement of defence aircraft, while orders from overseas increased 6.0%. Total machinery orders increased 18.8%.

EUROPE

  • As expected, the ECB left its monetary policy and forward guidance unchanged. The ECB reiterated its intention to halve monthly asset purchases from €30 billion to €15 billion in October, ending new purchases altogether at the end of December while keeping its key deposit rate unchanged at -0.4% “at least through the summer of 2019.” Despite the intensifying trade war, emerging market turbulence, and concerns over the Italian fiscal and economic outlook, ECB President Mario Draghi maintained an upbeat economic assessment. The ECB slightly lowered its GDP forecasts for 2018, 2019 and 2020 from a previous 2.1%, 1.9% and 1.7% to 2.0%, 1.8% and 1.7%, respectively but kept its inflation forecasts unchanged at 1.7% for all three years. However, the ECB noted that its policy plans will remain subject to incoming data and that it would continue to reinvest the proceeds of maturing bonds from its €2.5 trillion bond portfolio.
  • Eurozone industrial production unexpectedly fell in July by 0.8% month-on-month, its second straight monthly decline following a 0.8% decline in June. By industrial sector, production of durable consumer goods fell 1.9% and non-durable consumer goods by 1.3%. More encouragingly, capital goods production increased 0.8%. On a year-on-year basis, industrial production growth fell sharply from 2.3% in June to -0.1% although the contraction is partly due to the base effect of unusually strong production in the second half of last year. Monthly data tends to be volatile, so some recovery is expected over the remainder of the third quarter (Q3) in line with the manufacturing purchasing managers’ index (PMI), which continues to signal steady expansion. The PMI is consistent with annualised growth in industrial production of around 1.5% in August and September.
  • The German ZEW economic sentiment indicator improved in August from -13.7 to -10.6, a four-month high, better than the consensus forecast of -13.5. Although still well below the long-term average of 22.9 and in negative territory, the economic sentiment indicator is on the mend after hitting -24.7 in July, its lowest reading since August 2012. According to ZEW President Achim Wambach: “During the survey period, the currency crises in Turkey and Argentina intensified, while German industrial production and incoming orders were surprisingly low in July. Despite these unfavourable circumstances, economic expectations for Germany improved slightly.”

UNITED KINGDOM

  • As expected the Bank of England (BOE) voted unanimously to leave its base interest rate unchanged at 0.75% and its asset purchase programme at £445 billion. No change had been expected so soon after hiking the base rate by 25 basis-points at its August policy meeting. The BOE did not signal an imminent rate increase, guiding instead for rates to rise “at a gradual pace and to a limited extent” as long as there was a “smooth adjustment” to Brexit. The BOE will likely refrain from any further tightening in monetary policy until Brexit uncertainty has been resolved and in the event of there being no Brexit deal by the March deadline would likely cut interest rates as it did after the EU referendum.
  • Mark Carney, who announced in the past week that he would remain Bank of England (BOE) governor until January 2020, warned Theresa May’s cabinet that a disorderly Brexit would lead to economic chaos. He cautioned that the BOE would not be able to come to the rescue with monetary stimulus as it had done after the EU referendum, as inflation would be a threat. Carney warned that house prices would be 35% lower than would otherwise be the case three years after a no-deal Brexit, due to rising unemployment, higher inflation, higher interest rates and depressed economic growth. On the other hand, Carney stated that if a Brexit deal was struck as proposed by Theresa May to the EU in July, the economy would outperform the BOE’s current forecasts.
  • Average weekly earnings increased in July by solid 3.1% year-on-year up from 2.8% in June, marking the fastest pace since July 2015 and its joint-highest since 2008. The strong wage data came despite employment numbers rising in July by just 4,000 on a rolling 3-month basis, down sharply from 42,000 in June and 137,000 in May. However, the July data shows an underlying shift from part-time to full-time employment. While part-time workers fell by 98,000 full-time workers increased by 100,000. The employment report is beginning to reflect a combination of both strong jobs growth and strong real earnings growth. According to the Office for National Statistics the number of unfilled job vacancies reached its highest level since at least 2001 when the data series began. The strong recovery in earnings growth bodes well for household spending, which contributes over a third of UK GDP.

FAR EAST AND EMERGING MARKETS

  • India’s consumer price inflation (CPI) decelerated in July from 4.2% year-on-year to 3.7% below the Reserve Bank of India’s (RBI) 4% target for the first time since October 2017. However, the slowdown is attributed almost entirely to a sharp fall in food and beverage inflation from 1.7% to 0.9% due to the base effect of high year-ago comparative levels. Core CPI, which excludes food and energy prices due to their volatility, fell more modestly from 6.2% to 6.0%, well above the RBI’s target. Wholesale price inflation (WPI), also decelerated from 5.1% to 4.5% but the decline was again attributed to falling food price inflation. Food WPI fell in July from -2.2% on the year to -4.0%. Despite the encouraging data, underlying inflationary pressure is likely to stay if the economy maintains its current momentum amid strengthening wage growth and rising capacity utilisation, prompting further pre-emptive tightening from the RBI.

 

  • Turkey’s central bank hiked its benchmark repo rate from 17.75% to 24% defying president Erdogan’s call for lower rates. The central bank attributed the rate hike to a deterioration in the inflation outlook. It said it would “continue to use all available instruments in pursuit of the price stability objective.” In August, inflation jumped to almost 18% year-on-year. Meanwhile the lira has slumped versus the US dollar by around 40% since the start of the year. The interest rate hike exceeded the consensus market forecast for an increase to 22% and should help shore-up foreign investor confidence in the central bank’s independence. On the day of the rate decision the lira rallied over 5% against the dollar. The move should help quell broader emerging market currency turbulence, which initially spread from currency crises in Turkey and Argentina.

 

KEY MARKET INDICATORS (YEAR TO DATE %)

JSE All Share - 5.39

JSE Fini 15 - 9.20

JSE Indi 25 - 10.00

JSE Resi 20 + 18.39

R/$ - 17.10

R/€ - 14.77

R/£ - 14.70

S&P 500 + 8.05

Nikkei - 1.45

Hang Seng - 9.98

FTSE 100 - 5.02

DAX - 6.36

CAC 40 + 0.68

MSCI Emerging - 12.26

MSCI World + 2.71

Gold - 7.73

Platinum - 14.75

Brent oil + 17.38

 

TECHNICAL ANALYSIS

  • 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 the key resistance level of 60,000 in December signals the early stages of a new bull market.

BOTTOM LINE

  • The South African Reserve Bank (SARB) Monetary Policy Committee is unlikely to hike the repo rate at its policy meeting on Thursday despite the sharply weaker rand and rising interest rate expectations. The rand has depreciation 11% versus the US dollar since the beginning of August. Over this time, the Forward Rate Agreement (FRA) Market has repriced the interest rate outlook, now discounting a 75 basis-points increase in the repo rate over the next nine months.
  • Emerging market central banks have been hiking interest rates to shore-up their currencies. Since August, Argentina and Turkey, home to the worst affected emerging market currencies, have hiked their prescribed short-term interest rates from 40% to 60% and from 17.75% to 24%, respectively. India and Indonesia, have been steadily hiking interest rates since the start of the year.
  • According to the SARB the rand poses the biggest upside risk to the inflation outlook, particularly if recent rand weakness is sustained. Last month headline consumer price inflation (CPI) accelerated from 4.6% to 5.1% although the biggest culprit was the higher fuel price. Core CPI, which excludes food and energy prices due to their volatility, pickedup more modestly from 4.2% to 4.3%. The August CPI numbers, due to be released on Wednesday, will likely confirm a further acceleration, exacerbated by the rand’s weakness and the April VAT increase. However, core CPI should remain benign, sticking below the mid-point of the SARB’s 3-6% target range.
  • Unfortunately, the SARB has little influence on the rand. Any attempt to shore-up the rand by hiking interest rates would probably backfire, leading instead to a weakening in the currency. The more significant determinant of rand strength is GDP growth. In the week after South Africa officially entered into recession with the release of second quarter (Q2) GDP figures, the rand lost almost 4% against a basket of emerging market currencies. Slow GDP growth means reduced tax revenue, greater stress on the budget deficit and a more imminent danger of further credit rating downgrades.
  • The SARB, by hiking the repo rate, would undermine household disposable income, add further pressure on GDP growth, leading to even more rand weakness, and therefore additional rather than less inflationary pressure. Household spending, which is particularly vulnerable to rising interest rates, contributes over 60% to South Africa’s GDP.
  • Counter-intuitively, the SARB would be rewarded with a stronger rand if it resisted the temptation to hike the repo rate on Thursday. Lower interest rates will lead to stronger GDP growth and stronger capital inflows.
  • The SARB traditionally errs on the side of caution, far slower to react than most emerging market central banks to changing external conditions. This is borne out by far fewer interest rate changes. Just as the SARB was slow to respond to the 9% appreciation in the R/$ exchange rate in the month following last December’s ANC elective conference, the response to the current rand slump is likely to be equally measured. The SARB will most likely adjust its accompanying policy statement to reflect a more “hawkish” tone, cautioning against the increased risks of higher inflation. However, a rate increase is extremely unlikely especially with the country in recession.

 

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