TRY­ING TIMES FOR SOUTH AFRICAN ECON­OMY

Financial Mail - Investors Monthly - - Opening Bell - with Claire Bis­seker

In ad­di­tion to the on­go­ing risk of Fed tight­en­ing, some new in­fla­tion pres­sures have emerged

Last year was a ter­ri­ble one for the SA econ­omy. GDP data to be re­leased on March 7 will re­veal just how bad.

The Reuters con­sen­sus is that growth will come in at just 0.4% — the econ­omy’s worst per­for­mance since the 2009 re­ces­sion — while em­ploy­ment growth and per capita GDP growth are ex­pected to be neg­a­tive for the year as a whole.

Last year, cycli­cal shocks, the drought and SA’s self­de­struc­tive pol­i­tics — as typ­i­fied by the Hawks’ re­lent­less pur­suit of fi­nance min­is­ter Pravin Gord­han — com­bined to bring growth to a stand­still.

Con­sumers came un­der in­tense pres­sure. Thanks to the drought, real agri­cul­tural output con­tracted by dou­ble dig­its over the past two years. Food price in­fla­tion tre­bled in 2016, push­ing in­fla­tion up to 7% and gen­er­at­ing a 75 bps rise in in­ter­est rates over the year.

Am­pli­fy­ing the down­swing was a fur­ther slow­down in cap­i­tal ex­pen­di­ture. Af­ter four con­sec­u­tive quar­ters of con­trac­tion, gross fixed cap­i­tal for­ma­tion re­mains deep in re­ces­sion and un­em­ploy­ment at record highs.

KPMG econ­o­mist Christie Viljoen warns that the weak per­for­mance of the min­ing and man­u­fac­tur­ing sec­tors dur­ing the fi­nal quar­ter of 2016 sug­gests that SA likely posted GDP growth of lit­tle bet­ter than 0.5% y/y in the fourth quar­ter. This would yield an an­nual growth rate of 0.4% — well be­low most es­ti­mates at the start of 2016.

Both man­u­fac­tur­ing and min­ing will have acted as a drag on fourth quar­ter GDP growth, with re­cent data show­ing that man­u­fac­tur­ing pro­duc­tion growth con­tracted by -1.1% q/q in the quar­ter and min­ing by -2.7% q/q.

For the year as a whole, min­ing pro­duc­tion was down by 4.9% y/y, fol­low­ing an in­crease of 4.3% y/y in 2015, while man­u­fac­tur­ing output re­cov­ered to a weak 0.8% y/y in 2016 from -0.1% y/y in 2015.

Agri­cul­tural ac­tiv­ity is the main up­side risk to the 2016 GDP forecast, ac­cord­ing to Stan­lib chief econ­o­mist Kevin Lings. “Agri­cul­tural ac­tiv­ity should be pos­i­tive for the [fourth] quar­ter af­ter a poor third quar­ter read­ing and twoyear de­cline, but it’s dif­fi­cult to judge just how pos­i­tive.”

Pro­vided there is no wors­en­ing of the po­lit­i­cal back­drop, and SA con­tin­ues to avoid fur­ther credit-rat­ing down­grades, then the con­sen­sus is that the com­ing year is likely to bring a mild cycli­cal re­cov­ery to about 1.1% real GDP growth.

On March 16, the US Fed­eral Re­serve’s open mar­ket com­mit­tee (FOMC) will con­clude its sec­ond meet­ing of the year.

Ac­cord­ing to Fed­eral funds fu­tures con­tracts, the mar­ket is pric­ing in about two Fed hikes for the com­ing year with only a 24% prob­a­bil­ity of a hike at the March meet­ing, fol­low­ing the 25 bps in­crease in De­cem­ber. There­after, the odds of a May hike are 39%, ris­ing to 67% in June, 82% by the Septem­ber meet­ing and in­creas­ing cu­mu­la­tively af­ter that.

The Fed’s “dot plots” (the in­ter­est rate fore­casts of in­di­vid­ual FOMC mem­bers plot­ted as dots on a graph) sug­gest, how­ever, that three hikes are likely this year. The mar­ket’s view and the dot plots have dif­fered for quite some time.

His­tor­i­cally the dot plots have been “overly hawk­ish” and over time have tended to con­verge to­ward the mar­ket’s ex­pec­ta­tion, ac­cord­ing to Mo­hammed Nalla, head of strate­gic research and global mar­kets at Ned­bank Cor­po­rate & In­vest­ment Bank­ing.

At the start of 2016, for in­stance, the dot plots in­di­cated that four hikes were on the cards over the course of that year, whereas only one hike

At the start of 2016, for in­stance, the dot plots in­di­cated that four hikes were on the cards over the course of that year, whereas only one hike ac­tu­ally tran­spired

ac­tu­ally tran­spired.

Nalla ex­pects just one Fed hike this year, prob­a­bly in the third quar­ter, and for rates to re­main flat there­after, with the next move pos­si­bly pushed into early 2018. This is more dovish than the mar­ket con­sen­sus.

The risk to this view is that US in­fla­tion es­ca­lates ma­te­ri­ally but this is some­thing Nalla sees as a po­ten­tial risk for 2018 rather than the cur­rent year.

The lat­est US em­ploy­ment data sug­gests that while the econ­omy is grow­ing, in­fla­tion is not yet a cause for con­cern. Non­farm pay­rolls rose by a healthy 227,000 jobs in Jan­uary but wage growth re­mains con­tained. Over the past year, av­er­age hourly earn­ings have risen by just 2.5% in the US.

Lings be­lieves the Jan­uary em­ploy­ment data will en­cour­age the Fed to keep its hik­ing pro­file mod­est. He’s ex­pect­ing two hikes of 25 bps each — on June 14 and Septem­ber 20.

“There re­mains the pos­si­bil­ity of a hike on March 15,” he con­cedes, “but the Fed may de­cide to wait to see more fully the im­pact of [US pres­i­dent Don­ald] Trump on the US econ­omy.”

Trump’s as­cen­sion to the White House and his prom­ises of un­bri­dled fis­cal stim­u­lus have cre­ated a more chal­leng­ing en­vi­ron­ment for emerg­ing mar­kets, un­der­min­ing hopes that rate cuts might be on the cards in SA this year.

Specif­i­cally, higher US long bond yields on ex­pec­ta­tions of tighter US mon­e­tary pol­icy have caused cap­i­tal out­flows from emerg­ing mar­kets rem­i­nis­cent of mar­ket re­ac­tion to the US “ta­per tantrum” in 2013.

While the rand has dis­played some re­silience of late, SA’s mon­e­tary pol­icy com­mit­tee (MPC) noted in Jan­uary that risks to the rand could re- emerge at any stage.

The MPC will have had the ben­e­fit of the Fed’s March rates de­ci­sion — and the rand’s re­ac­tion — when it con­cludes its next meet­ing on March 30.

Since the re­cent trough of 5% in 2013, the Re­serve Bank has hiked the repo rate by 200 bps in re­sponse to broad­en­ing in­fla­tion­ary pres­sures. Last year, it im­posed 75 bps of cu­mu­la­tive hikes, bring­ing the repo rate to 7%.

The Reuters con­sen­sus is that the repo rate will re­main flat at 7% through­out 2017 with the first cut com­ing only in the first quar­ter of 2018.

In ad­di­tion to the on­go­ing risk of Fed tight­en­ing, some new in­fla­tion pres­sures have emerged. These in­clude the firm­ing of oil prices in re­sponse to Opec’s re­cent agree­ment to cut output, and sticky do­mes­tic food prices de­spite im­proved rain­fall in many drought-stricken ar­eas.

The MPC re­vised up its in­fla­tion forecast ac­cord­ingly in Jan­uary. It now ex­pects con­sumer in­fla­tion to fall back within the 3%-6% tar­get band only in the fourth quar­ter of this year and to av­er­age 6.2% for the year, com­pared with 5.8% pre­vi­ously.

It adopted a hawk­ish tone at the Jan­uary meet­ing, stat­ing that while it still be­lieves SA “may be near to the end of the hik­ing cy­cle”, the de­te­ri­o­ra­tion of the shorter-term out­look re­quires in­creased vig­i­lance.

“I ex­pect to see rates on hold for most if not all of this year,” says Nalla. “The up­side in­fla­tion sur­prise in De­cem­ber cou­pled with some tail risks in food in­fla­tion em­a­nat­ing from higher meat prices and risks to grains from the army worm in­fes­ta­tion will keep the Re­serve Bank cau­tious.”

Lings also ex­pects the Bank to keep rates on hold but re­main fairly hawk­ish while it as­sesses a range of fac­tors, in­clud­ing the im­pact of Trump’s vic­tory on emerg­ing economies and the risk that the SA econ­omy fails to lift growth in 2017.

“The bank is also clearly mind­ful of the on­go­ing risk of a credit-rat­ing down­grade, which may re­quire a pol­icy re­sponse,” he adds. “While we ex­pect rates to re­main on hold in the short to medium term, it is still pre­ma­ture to forecast that the next move in in­ter­est rates will be a cut.”

Other events to watch out for in­clude the EU Sum­mit on March 9-10 at which Bri­tish PM Theresa May could trig­ger ar­ti­cle 50, be­gin­ning Bri­tain’s process of leav­ing the EU.

Also im­por­tant is the Dutch gen­eral elec­tion on March 15, but only as a bell­wether of the mood of Euro­pean vot­ers given the loom­ing French elec­tion.

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