SOME RED-LET­TER DAYS LIE AHEAD IN SEPTEM­BER

Financial Mail - Investors Monthly - - Con­tents - with Claire Bis­seker

ECON­OMY WATCH

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

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