Market Wrap
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Markets @ Bidvest Bank - 24 June 2014

By Bidvest Bank
24-06-2014
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Fundamentals:

US
• Existing home sales in April posted softer than expected growth of 1.3% on the month from a 0.2% contraction previously (expectations: 2.2%). This saw the annualized total rise to 4.65mn from 4.59mn, the first increase since December 2013 off nearly 2-year lows. Fed policymakers have flagged the housing sector’s under-performance as an area of concern and will be hoping for some improvement in the months ahead.
• This week could prove an important one for US “holdout” investors who did not accept the 2002 debt restructure and who refused to accept a further 2005 and 2010 debt restructure of those debt securities.  The US Supreme Court decline to hear the appeal of Argentina which leaves the ruling that payment of the restructured debt cannot proceed without the payment of the holdouts as well.  Argentinean default risks loom large.
UK:
• BoE MPC member David Miles was quoted yesterday as saying that the soft state of inflation in the UK would allow policy makers to lift interest rates only gradually.  Interestingly, Miles has indicated that the level at which rates settle post normalisation in economic conditions will likely be lower than the 5% seen prior to the crisis in 2008.  This is a good indication that the authorities have no plans to unravel the gains in asset prices which have gone some way to repairing household balance sheets.
• Infrastructure is a priority in Britain and would be highlighted by the East-West rail link between cities in northern England.  A North-South link is already planned.  The idea is to promote the economy outside of London.
Asia:
• The Markit/JMMA flash manufacturing PMI pointed to an increase in activity for the first time in three months in June, rising for the second month to 51.1 vs. 49.9 in May, stronger than expected. Both output and new orders expanded, suggesting that the sector is recovering from the negative impact that the sales tax had earlier this year. China’s HSBC Flash manufacturing PMI similarly rose in June to 50.8, marking a seven month high. Data at the start of the week pointing to improved regional growth dynamics.
• BoJ Gov. Kuroda will be speaking in Tokyo at 06:00GMT. The Gov. on Friday in indicated that a moderate growth recovery was underway and that the BoJ’s massive bond buying programme is having the desired impact on prices.
EU:
• ECB Pres. Draghi an interview over the weekend spoke more liberally about QE than has been the case in the past, saying outright that purchases of government bonds in addition to private sector assets are within the Bank’s price stability mandate. As was the case with Constancio, however, the Pres. maintained that the Bank was focusing on current measures and that deflation is still not expected. While we expect policymakers to continue talking up such prospects to manage expectations and attempt to engineer a market response from the communications channel, the hurdles to actual deployment of QE are high.
• Preliminary EZ manufacturing and services PMIs are in focus today, but are expected to be little-changed. The Zone’s constrained cyclical dynamics remain ever-present and bias continued sub-standard growth performance.
 

Developments worth noting:
• The Chinese HSBC manufacturing PMI overnight has topped expectations, rising above the neutral 50 mark for the first time in six months to 50.8. The boost has come through stronger new orders and it appears on the surface that the effort by Chinese policymakers to provide stimulus at the margin has helped support a modest recovery. Bearing in mind that China is still in the midst of a downswing it is difficult to read too positively into these figures and in terms of the impact on rates markets more than anything this is likely to have significance for short-term currency movements. The Aussie dollar has responded positively similar to other Asian EM currencies and we may well see a similar boost for the rand to come.
• It is not guaranteed that we see similar currency reactions to US and UK growth indicators where higher rate expectations have been threatening in these two major economies. It holds the potential to drive up the short-end of the rates curves in these markets and while subsequently higher rate expectations locally can be a rand positive, the SARB first needs to prove it is willing to stomach another rate hike in very weak growth conditions. A SARB that is stubborn in raising rates despite pressures from abroad and rising inflation implies the risk of the local bond curve flattening more slowly than it otherwise would during a rising inflation hike cycle.
• When it comes to inflation, our broader view has been that of CPI potentially topping out this quarter and heading nearer to the target band over subsequent quarters, as demand has not been strong enough to allow a meaningful pass-through and given that global food price indicators have started to soften. However, another short-term risk exists and that is the developing war in Iraq which has pushed the price of Brent crude up to Sept 2013 highs of $115/bl. More concerning is the record high rand price of Brent crude which on a y/y basis is also very elevated around 23%, warning of a CPI trajectory that is perhaps stickier as domestic fuel prices are somewhat inelastic. However it is the rand that is key to the interest rate outlook in a broader sense and without a deeper sell-off the SARB will retain the ability to talk itself out of the immediate need to hike.
Data/Events for the next week:
• The local calendar brings second-tier releases this week but ones that do nevertheless still offer some interest. The Apr leading indicator, which offers insight into the SARB’s thinking around growth prospects, is likely to remain subdued after falling to Q3/2012 lows of 99.1 in Mar. PPI meanwhile is generally expected to start showing an alleviation of upside price pressures in the months ahead but still remain quite buoyant overall, with added risk presenting itself in the short term as the rand price of Brent crude rises to record highs.
• Offshore, beyond the manufacturing PMIs today, focus will be on US and UK housing data with the US sector still showing signs of demand constraints while the latter is being monitored for signs of how sustainable surging price growth is.


Trade Weighted ZAR:

• Early last week the trade-weighted rand hit its worst levels since the final week of Mar, taking its year-to-date depreciation up to 2.9%. Since then, we have seen the local currency recover marginally to a year-to-date decline of a more modest 1.5%, a recovery which has been broad-based and which follows on from the better than expected Q1 current account print. Being a major part of the rand’s underlying fragility, a narrowing of the deficit was certainly encouraging, suggesting that there is less pressure from an external financing perspective to keep the rand propped up.
• However, it remains to be seen whether such a narrowing is sustainable when the outlook on the trade account is still worrying amidst local interest rates locally and subdued offshore demand. Furthermore, it is just one aspect of the rand’s fragile status with the other being negative real interest rates as a means to suppress long-term capital inflows, a measure which has deepened more now after the lastest 6.6% y/y CPI print. A SARB that continues to be reluctant in raising rates meaningfully will leave the rand exposed to some degree.
• The other factors working in favour of the rand presently are those of the improved Chinese manufacturing PMI and news of potential resolution to the platinum sector strike. However, it will take some time for production to resume beyond the end of the strike and one should question the benefit will be SA reaping from the latest Chinese demand upliftment when met with a failure to produce domestically. The weak growth outlook in the SA economy is likely to reaffirmed in the SARB leading indicator data due tomorrow.
• Take note: The trade-weighted rand calculation will be adjusted on July 1 by the SARB as it has revised its country trade weightings. Details to follow in next week’s commentary.



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