There was no stopping the flow of bad economic news in July. However, SA’s financial markets largely avoided contagion from the Grexit drama which, like China’s equity rout, has abated for now.
But while the worst global risks appear to have been dodged, key domestic economic indicators continued to decline over the past month. This sets a grim tone for SA’s second quarter GDP number, which will be released at the end of August. And on July 23 Reserve Bank Governor Lesetja Kganyago hiked interest rates by 25 basis points.
Of the slew of negative data released in July, the most shocking was the collapse in the First National Bank/Bureau for Economic Research consumer confidence index (CCI) and the SA Chamber of Commerce & Industry’s business confidence index to around 15-year lows. Both are lower than at the start of the 2009 recession.
For Rand Merchant Bank chief economist Ettienne le Roux, the sharp drop in the “time to buy durable goods” sub-index of the CCI is “a terrible omen” for the consumer-facing sectors.
For instance, it suggests a continued, if not faster, decline in new passenger car sales volumes. The passenger car market has been in decline since mid-2013, with the average daily selling rate in June the lowest since May last year. Real retail sales also remained flat in May for the third month running when adjusted for seasonal patterns.
“Consumers are clearly quite fragile at the moment,” says Le Roux. “Worrying too, is that the bad news was not only limited to the demand side of the economy. Manufacturing output again contracted in the month, as did mining production. The economy is being buffeted from all over — a most unfortunate situation.”
Economists are braced for another disappointment when the second quarter GDP number is released later this month. SA achieved growth of just 1,3% q/q in the first quarter. The Reuters consensus is for growth of no more than 1,9% this year, rising to 2,2% in 2016 and 2,6% in 2017, assuming an easing of the electricity supply constraint.
Confirming the impression that the economy is headed for continued stagnation at best, the Reserve Bank’s leading indicator contracted in May for the 20th straight month by a significant 3,4% y/y (against April’s decline of 1,5%). This is its weakest level since November 2009.
Crucial to SA’s growth prospects is the health of its key trading partners, China and Europe.
Barclays’ currency strategist Mike Keenan says the best guide as to whether China’s slowdown is gaining momentum is not the performance of the Chinese equity market but the extent of fall-off in its demand for commodities and hence the movement in commodity prices.
At the time of writing, gold had fallen below the psychological $1 100 barrier, tumbling to $1 072/oz — its lowest level in nearly five-and-a-half years. Silver, platinum and palladium had also hit multiyear lows.
The weakness in commodity prices is being fuelled not just by China’s slowing, but also by a resurgent dollar. (A strong dollar raises the price of commodities for buyers with relatively weaker currencies, depressing global demand and hence prices.)
The dollar’s rise has been given fresh legs by Federal
Sharp drop in sub-index of the CCI is ‘a terrible omen’ for the consumer-facing sectors
Reserve chair Janet Yellen’s recent statement that she expects the Fed to raise interest rates before the end of 2015. This goes against the advice of the International Monetary Fund, which in June urged the Fed to wait until 2016, cautioning that there was too much uncertainty to justify a hike this year.
Market-watchers will have noted the language used by the Fed at its meeting this week, as well as on US data on wages and employment over the coming month in order to obtain greater clarity about the lift-off date.
US economic data has been improving steadily, suggesting the Fed could lift off as early as September (futures markets are pricing in a 50% chance of this) but the strengthening dollar implies an implicit tightening of the US economy since it reduces the competitiveness of US exports.
Also, raising US rates now would be detrimental to global growth. With the eurozone’s fragile recovery threatened by the turmoil in Greece, and China’s growth outlook in question, this would seem to count against the possibility of an early hike.
“The US is not an island. It needs to keep a very close handle on the growth prospects of its main trading partners,” says Keenan. On the other hand, he concedes that it is unclear to what extent the US factors in global considerations when making monetary policy decisions.
As a former treasury secretary famously once joked: “My currency, your problem!”
Keenan believes that the central banks of the US and SA are both facing “a watershed moment”. Neither is facing the exponential increase in demand that justifies the need to hike rates at their next meeting, in his view. Yet, for credibility reasons, there is a limit to how long both banks can keep talking tough but doing nothing.
Speaking at the annual BER conference in Johannesburg in June, Reserve Bank deputy governor Daniel Mminele warned that US policy normalisation could result in further weakness in the rand against the dollar, and could also negatively affect portfolio flows by reducing the willingness of fund managers to hold unhedged positions in South African bonds and equities.
At the same time, a weaker exchange rate would probably raise implied rand volatility, adding to overall risk aversion and weak sentiment towards rand-denominated assets.
This risk was illustrated during the 2013 taper tantrum, he said, during which the rand lost 10% of its value against the dollar and portfolio flows into SA reversed from an R85bn inflow in 2012 to an outflow of R55,5bn in 2014.
In the year to date, foreigners have bought R41,5bn worth of equities and R11,6bn worth of SA government bonds. SA’s dependence on these continued inflows to finance the current-account deficit makes it vulnerable to US policy tightening.
Also, any significant weakening of the exchange rate in reaction to US monetary policy tightening could worsen SA’s inflation outlook.
The other chief domestic risk to the inflation outlook is higher-than-expected wage settlements. As such, the ongoing wage talks in the gold and coal sector have become an important barometer of second-round inflation risk.
After four weeks of gold mining wage talks, the parties are still far apart — with employers having refused to revise their wage offer of 7,8% to 13% at the entry level against the unions’ demands for increases of up to 100%.
With confidence in tatters and economic growth beset with downside risks, SA needs to avoid a mining strike at all costs. In this respect, August looks set to become a crucial month.
Crucial to SA’s growth prospects is the health of trading partners China and Europe US economic data has been improving steadily, suggesting the Fed could lift off as early as September