SOME RED-LETTER DAYS LIE AHEAD IN SEPTEMBER
September will be an important month for the South African economy, hopefully delivering proof that the country has avoided a recession and that the inflation outlook has brightened. If the US Federal Reserve can remain dovish and the rand hold on to its recent gains, SA may be able to avoid further rate hikes this year.
The first red-letter day for the economy will be September 6, when Stats SA is set to release SA’s second-quarter GDP data.
Encouraging local mining and manufacturing production data, together with the improvement in retail trade in May, suggest that SA didn’t sink into a technical recession in the second quarter but regained a bit of positive momentum after a disastrous 1.2% q/q annualised contraction in the first quarter.
A technical recession is defined as two quarters of negative GDP growth.
Mining output rebounded to 17.4% during the second quarter on an annualised basis, reversing the 18.1% contraction that occurred in the first quarter.
Manufacturing production has also improved. In the second quarter, manufacturing grew by 2% q/q, including annual growth of 4.5% in June — the highest annual rate of growth in more than a year.
Stanlib chief economist Kevin Lings says: “The most recent improvement in manufacturing production is very encouraging and could be signalling a revitalisation of the manufacturing sector supported by the combination of import substitution and some currency induced improvement in exports.”
Rashad Cassim, Monetary Policy Committee (MPC) member and the Reserve Bank’s head of research, confirmed to journalists last month that it was now unlikely that SA would enter a technical recession. However, SA was still stuck in a “low-growth trap”.
The Bank forecasts 0% growth this year and below-trend growth of just 1,1% and 1,5% in 2017 and 2018. So while SA is likely to avoid a technical recession, it is still mired in a “growth recession” in the sense that the country is growing well below its potential.
The Reuters consensus for August is that GDP will average 0.2% for the year as a whole, posting growth of 0.9% in the second quarter, 0.4% in the third quarter and 0.5% in the final quarter.
Another key event to circle in September is the US Federal Open Market Committee’s (FOMC) two-day meeting, which ends on September 21.
At the time of writing, the market-implied probability that the Fed would raise the Fed funds rate was just 16% for the September meeting, rising to 17% in November and 42% in December. In other words, the market still doubts that the Fed will hike even once this year.
This is informed by the global trend towards looser monetary policy following the Brexit vote on June 23. The UK’s decision to leave the European Union has clouded the growth outlook for the UK and Europe, dented global confidence and fuelled the dollar’s strength against the pound and euro, though it has tracked sideways on a trade-weighted basis.
On the other hand, the US jobs market continues to improve. In July, US non-farm payrolls rose by an impressive 255,000 jobs. US job gains have averaged 186,000/month so far this year.
“It’s hard to imagine a better all-round labour market report given the upward revision to the previous two months’ employment data, a rise in the labour market participation rate, a solid gain in wages, and a steady unemployment rate,” said Lings of the July data.
Soon after this report, San Francisco Fed official John Williams said he believed the Fed should raise rates at least once this year. This would reflect improved labour market conditions and the likelihood that inflation was heading higher.
Another key event to circle is the US Federal Open Market Committee’s two-day meeting, which ends on September 21
The Fed raised benchmark US rates last December for the first time in nearly a decade but, contrary to initial expectations that it would raise rates several times this year, has kept them on hold ever since. It has been reluctant to hike into a tentative global growth environment, given signs of a steeper slowdown in China and, more recently, over contagion fears from Brexit.
SA’s Reserve Bank will have had the benefit of the FOMC rates decision before having to make its own call on rates the following day — September 22.
In the unlikely event that the FOMC surprises the markets by raising rates, the rand will probably weaken in tandem with a rising dollar, putting pressure on the Bank to hike the domestic policy rate to ward off the potential pass-through into higher inflation.
Ten local economists surveyed by Reuters early in July said they expected the Bank to raise rates by 25 bp at the September meeting while eight said they expected rates to rise only at the November meeting.
In early July, however, the rand was still trading at around R14.50/$. By early August it had strengthened to a 10-month high of R13.30/$ buoyed by a general rise in risk sentiment towards emerging markets, caused mainly by developed-country central banks’ post-Brexit dovishness.
The big question is whether the rand can sustain these gains, helping to moderate SA’s inflation outlook. Inflation is outside the target range of 3%-6% and is expected to remain there until the third quarter of 2017. Inflation is being driven mainly by drought-induced food price hikes, a relatively depreciated currency and administered prices.
Reuters’ August poll expects recent rand strength will improve the inflation outlook, with only four economists still expecting a 25 bp rate hike at the September meeting against nine who now expect a November hike.
Even more interesting is that whereas in the July poll, the consensus was that no rates cuts were on the cards, in the August poll the consensus has shifted to price in a 25 bp cut in the third quarter of 2017.
Nomura economist Peter Attard Montalto thinks a “surprisingly large” number of hedge funds and local economists, whom he dubs “the Sandton consensus”, now view cuts as highly likely.
However, recent commentary from the Bank suggests that it is pushing back against this view.
Addressing a Free State University function last month, deputy governor Francois Groepe said while the Bank was aware that tightening monetary policy could have a negative impact on the economy, the failure to act could cause inflation expectations to become unhinged and ultimately undermine inflation.
He said the Bank could not ignore second-round effects — where higher prices feed into higher generalised inflation and higher wage settlements. “If we ignore these pressures, inflation expectations are likely to rise,” he said. “And if wage negotiators and price-setters believe inflation will accelerate, they will adjust wages and prices accordingly and bring about a self-fulfilling prophecy.”
Attard Montalto feels expectations of a cut rest on a fundamental misunderstanding of the MPC framework. “The MPC’s mantra is not [to] cut wherever and whenever possible, it is . . . [to] pause if you can,” he explains.
Nor does the Bank think in binary terms of either hiking or cutting and flip between the two modes. Rather, it compares the actual policy rate with what it considers a neutral level of around 7.5%.
Therefore, at 7% against current inflation of 6.3%, it views SA’s real rates as still quite low.
Groepe confirmed this in his speech, describing the gradual 200 bp hiking cycle SA has experienced since January 2014 as “moderate”. The tightening would have been more aggressive had the economy been more buoyant, he explained.
“Furthermore, real interest rates remain relatively low, implying an accommodative monetary policy stance despite the tightening.”
The upshot is that though the stronger rand and lower oil price, along with some recent moderation in international and domestic wheat and maize prices, suggest better inflation prospects, no rate cuts are imminent.
At best, SA can hope for a prolonged pause — hopefully into next year.
Of course, if the Fed hikes and the rand fails to hold on to its gains, all bets are off.
Furthermore, real interest rates remain relatively low, implying an accommodative monetary policy stance despite the tightening