Market Wrap

Markets @ Bidvest Bank - 04 August 2014

By Bidvest Bank
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• Two Fed officials in the form of Charles Plosser and Richard Fisher have both hinted that rates in the US might be lifted sooner than many initially anticipated. The comments made must be looked at in context with both these Fed speakers known for their more hawkish stance on monetary policy and are likely to be outvoted by the remainder of the FOMC board members who are still expected to push for a tightening only in H2 2014.
• To the point, a poll conducted by Reuters shows that 12 of 18 primary dealers polled do not expect the Fed to hike rates before H2 2015, with the median long-term neutral target rate shifting to 3.5% vs the Fed’s 3.75%. The Fed is expected to adopt a range for the Fed funds rate.
• According to Reuters polls, no change in policy is expected at the upcoming MPC decision on Thursday but there is an expectation that we will see the first dissenter to the current on-hold interest rate position. As we see the UK cyclical recovery continue to unfold, talk of tightening monetary policy is certainly expected to gain traction. However, it remains doubtful that the bank chooses to pull the trigger in this regard in the near future. Tighter mortgage lending standards have helped to ease the upside pressure on house price growth which removes part of the immediacy to act.
• According to the CBI, the improvement in the labour market has helped boost small and medium sized businesses, despite export orders being mostly flat. The CBI confirmed that order books and output growing for the fourth consecutive quarter. The CBI has put pressure on the authorities to help boost the country’s overall export performance.
• A quiet start to the week with the only local data on tap the monetary base details for July. The base expanded at a slightly stronger y/y rate of 42.7% to ¥243.2tn, which compares with growth of 42.6% in June, and marks the first time since February that growth accelerates. Economic and price growth remains underpinned by ultra-loose policy and therefore robust growth in Japan’s monetary base is likely to remain a feature.
• Speaking in Sau Paulo over the weekend as part of a so-called five-country tour, PM Abe underscored how Latin America is viewed as an “indispensable partner” given its “large presence on the international stage”. He suggested the visit was aimed at starting a “new chapter” between the two countries, with at least $500mn worth of deals signed on Abe’s visit.
• The EC indicated over the weekend that the planned €4.9bn bailout of Banco Espirito Santo is in line with EU state aid rules.  This will help support the bank and prevent a disorderly collapse of the bank which would have had a destabilising effect on the Portuguese economy.  This will see this bank failure drift back to the side lines as an event of significance.
• In summary, the PMI data out of the EZ recorded in aggregate a slight deterioration in output to a 10m low, with price pressures easing and helping to lower the overall PMI reading.  It had been hoped that a mild improvement would have been seen, but fiscal headwinds remain strong.

Developments worth noting:
• On Friday, the US non-farm payrolls data showed a headline job expansion of 209k for Jul, a sixth consecutive month of growth above 200k, alongside an ISM manufacturing PMI that has risen to an early 2011 high of 57.1. The data broadly tends to confirm that the US cyclical rebound is on-going and provides a positive hint as to growth prospects into the early stages of Q3. However, it should also be noted that the payrolls data still shows evidence of qualitative weakness where an unemployment rate that ticked up to 6.2% from 6.1%, average hourly earnings which were below expectations and a labour force participation rate that remains subdued at 62.9% are elements which can be factored into the Fed’s view of slack remaining in the labour market.
• When taking this into consideration, it was interesting to note how the Fed funds future rates fell sharply on Friday to roughly two-week lows when looking at the Jun and Dec 2015 contracts in particular. We had started to see signs of lethargy in the dollar rally which had extended too far in the short term and came off its best monthly performance in Jul since early 2013, and such a retreat on the Fed funds futures would have assisted in generating this sort of dollar profit-taking. It perhaps offers a hint as to a market that does not see job and wage growth as a high enough risk prompting an immediate Fed reaction, as we have been saying for some time. Fed members Plosser and Fisher have been on the wires warning of sooner than expected rate hikes, but both members are known hawks.
• It comes as somewhat of a relief to the local markets at a time when domestic fundamentals have been increasingly punishing toward investor sentiment. Though the trade data last week produced a positive surprise on the headline print for June and should draw positively on the rebounds being experienced in China and the US, on a cumulative year-to-date basis the deficit came in at a record high. Following on from this was a Kagiso PMI and Naama vehicle sales growth y/y which remained in contraction territory to reflect further on the weakness of the underlying economy. Though many of these issues are characterised by structural shortfalls including counterproductive labour and business policies, it does not help that interest rates are kept artificially low in an attempt to fuel a consumption recovery, as it sows the seeds for more unsustainable rebounds.
Data/Events for the next week:
• The HSBC manufacturing PMI is due tomorrow and is expected to show a similarly subdued outlook as that seen in the Kagiso PMI last week. Of more interest will be the SACCI business confidence index and Jun manufacturing production data on Thursday which will provide deeper insight into the productive sector and challenges that continue to be faced from the prior strike action and on-going strain on demand. The economic growth trajectory remains weak and we would expect this to be reflected in these readings too.
• The US ISM services PMI will be the key PMI in focus tomorrow with other major regions offering only final revisions to earlier readings. The ISM reading is expected to remain buoyed as part of the cyclical rebound unfolding. Beyond this, the BoE and ECB rate decisions will hold interest with the ECB under pressure to respond to persistent weak growth and disinflation conditions but likely to adopt a wait-and-see approach after introducing new policy measures previously.

Trade Weighted ZAR:

• The rand has been offered some relief through dollar profit-taking that has emerged since Friday. The dollar index had been rallying steadily for many weeks previously and a payrolls print that missed expectations helped to entice this pullback. This resulted in the first day of gains for the trade-weighted rand in a week, and we have seen further consolidation of the losses into the start of this week to take month- and year-to-date performance of the currency to +0.7% and -0.7% respectively. This compares with a flat year-to-date performance a week ago.
• Looking at the broader trend, the deterioration we have started to see on the trade-weighted rand is one based on weak underlying fundamentals. Rising US interest rate expectations have been a negative for most EM currencies as a whole, but should be seen more so as the catalyst for uncovering the shortfalls that certain riskier EMs continue to be characterised by. The rand remains highly fragile and part of the reason for this is the still high twin deficits. The trade deficit for H1/2014 came in at a record high for this period of the year while the government budget balance showed what is expected to be only temporary improvement in June as soft growth will exert pressure on revenue collections going forward.
• Weakness on the growth front has knock-on effects when it comes to the interest rate and credit ratings outlook. Though the SARB may be forced to hike again should the rand continue to weaken, one should keep in mind that are in the midst of what will be a very shallow hike cycle due to weak growth, leaving interest rates in negative territory on a real basis which is a fundamental concern to the rand through dissuading savings. We are also bordering on junk ratings from the likes of S&P with further hints of downgrades thus to be taken especially negatively by the foreign investor community. It is to say that the rand is susceptible to more pronounced periods of weakness than strength.

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