The Reserve Bank announced its note issue for January this morning. This enables us to complete our Hard Number Index (HNI) of the immediate state of the SA economy. Our HNI combines unit vehicle sales with the note issue (adjusted for inflation in equal weights) to provide a very up to date indicator. We compare trends in the HNI with the Reserve Bank coinciding indicator of the state of the business cycle, although this has only been updated to October 2010. Three months can be a very long time in economic life. Continue reading The Hard Number Index: Recovery remains well on course
Category: SA Economy
New vehicle sales: A bright start to the year
The first bit of news about the SA economy in 2011 has been released by NAAMSA in the form of new vehicle sales in January. 45 135 new units were sold in January 2011, up from 39 504 in December 2010. But this does not tell the full story of very robust sales. January and December are usually well below par months for selling new vehicles. Holiday makers are more likely to buying Christmas presents for others than new toys for themselves.
On a seasonally adjusted basis new vehicle sales were up from 45 404 units in December to 45 758 units in January, an increase of 7.4%. This followed a very strong November. If these trends are sustained, sales in 2011 will approximate 585 000 units, up 18% from the 494 340 units sold in 2010. Continue reading New vehicle sales: A bright start to the year
Value for money and value add at the GSB Cape Town
Our readers may not have noticed but the Financial Times ranking of Business Schools around the world was published yesterday. The top schools as estimated by the schools themselves and by the opinions of their alumni were jointly the London Business School and the Wharton School at the University of Pennsylvania. Third was Harvard and joint fourth, Insead and Stanford Business School.
In 60th place up from 89 in 2010 was the GSB at the University of Cape Town. It is the only business school in Africa that is ranked in the FT top 100. Most interestingly the Cape Town GSB ranked first in the Value for Money Category. This has a low three per cent weight in the overall score and so could not have made a great difference to the ranking order. Much more important for the ranking Measure are the categories Weighted Salary with a 20% weight (the average alumnus salary today with adjustment for salary variations between industry sectors. Includes data for the current year and the one or two preceding years where available) and the Salary Percentage Increase with another 20% weight (The percentage increase in average alumnus salary from before the MBA to today as a percentage of the pre-MBA salary). Continue reading Value for money and value add at the GSB Cape Town
Turbulence on the Nile – ripples elsewhere
The likely fall of an Egyptian Pharaoh, after a very long reign, added uncertainty to global markets last week. Exposure to equities was reduced and share markets retreated with most of the weakness experienced on the Friday. A weaker rand made the JSE an underperforming Emerging Market in USD. The weak rand furthermore did not spare the Resource stocks that are regarded as riskier than most. (See below)
Global Equity markets Weekly USD returns; January 23rd= 100
JSE Weekly Rand returns; January 23rd= 100
Earnings: The trend is your friend – but which trend?
JSE All share index earnings are highly cyclical. And the cycle is one of high peaks and deep troughs in the growth rate ofearnings, as the illustration of the cycle of inflation adjusted or real earnings growth for the JSE since 1961 shows.The cycle has been particularly vicious lately. After a surge in earnings growth after 2004, which was sustained until 2008, thegrowth cycle turned very negative in 2009-2010. Real earnings at the bottom of the trough in late 2009 were some 40% lower thana year before. This represented the deepest trough in the JSE earnings cycle since 1960. Real JSE earnings growth turnedpositive again late in 2010 and consensus forecasts would have them grow by about 25% in 2011.
Continue reading today’s Daily View here: Daily View 26 January 2011
The building cycle: When a plan comes together
There are increasing signs that the global economic recovery is building momentum, and is very strong in many instances. We saw this last week with Chinese GDP numbers for the fourth quarter, which grew at an annualised 12.7%. But even in the developed world the signs are looking promising, with good business activity survey numbers out of Japan and Germany, and a promising set of jobless claims numbers out of the US last week.
Continue reading the Daily View here: Daily View 24 January 2011
Minding the Gap
The Monetary Policy Committee (MPC) of the Reserve Bank opted to keep the repo rate unchanged at 5.5% yesterday, in a move entirely in line with market expectations. Perhaps of more interest was the MPC’s outlook for inflation, which it upped to 4.6% for 2011 (from 4.3%) and 5.3% for 2012 (from 5.8%). We discuss the monetary stance of the MPC elsewhere in Daily View, but there has certainly been more talk in recent weeks of higher inflation later this year, as a weaker rand and rising commodity prices take their toll.
Continue reading the Daily View here: Daily View 21 January 2011
Hard Number Index: SA looks set fair for growth
The Reserve Bank on Friday 9 April reported the number of its notes circulating at the end of March. This enables us to update our Hard Number Index (HNI) of the SA Business Cycle that combines vehicle sales, also available for March 2010, with the real money base, that is the note issue deflated by the CPI.
The HNI is pointing firmly upwards, confirming very clearly that the SA economy has entered a new upswing phase in the SA business cycle (see below). Higher numbers indicate that the economy is expanding, that is, the economy is delivering positive rates of growth that will be confirmed in due course by a much wider selection of economic time series. First quarter GDP numbers for example will only be released in June 2010.
The second derivative of the business cycle, that is the rate of change of the HNI, is also in positive territory and indicates that growth is accelerating. The economy according to the HNI began to grow again in the fourth quarter of 2009, as confirmed by the National Income statistics for the quarter. It is picking up momentum.
As we reported previously, the new vehicle cycle is demonstrating very strong growth. The growth trend in vehicle sales is pointing sharply higher.
The growth in the note issue picked up in March 2010. However when these numbers are adjusted for the declining trend in the CPI the real money base is indicating positive growth rates at a modest rate (see below).
It should be appreciated that the note issue will grow in line with extra demands for cash that reflect the state of the economy. It is therefore a very good coinciding indicator of the state of the economy rather than a leading indicator. Growth in the supply of cash does not lead the economy but follows it. Nor is it a policy instrument of the Reserve Bank, though we have argued it should be. However the note issue has the great advantage for economic forecasters of being a very up to date indicator of the current state of the economy. Most economic indicators provide only a rear view mirror of the state of the economy.
The HNI overcomes the problem of driving along the economic track through the rear view mirror. The index, as we have shown, tracks the official business cycle indicator of the Reserve Bank very closely. It has the advantage of being very up to date as well as being based on hard numbers – actual vehicle sales and the note issue. The release of the Reserve Bank’s Coinciding Indicator of the SA business cycle by contrast lags behind economic events by three to four months (the latest number is for December).
The HNI therefore estimates the immediate state of the economy and the current estimate leaves little doubt that the economy is in a cyclical upswing and is accelerating.
SA economy: Hard numbers reveal hard times
Statistics recently released for new vehicle sales and the note issue of the Reserve Bank in October 2009 do not indicate that any recovery of the SA economy is under way. The data suggest if anything that the SA economy has continued to shrink at a faster rate.
These two very up to date economic series, vehicle sales and the note issue, both actual numbers rather than estimates derived from sample surveys, make up our Hard Number Indicator (HNI) of the state of the economy (we adjust the note issue for consumer prices). As may be seen below our Hard Number Index (HNI) tracks the coinciding business cycle indicator of the Reserve Bank very closely. As may also be seen the HNI calculated to October 2009 is still falling while the Reserve Bank Coinciding Business Cycle Indicator, available only to July 2009, has levelled off.
The Hard Number Index and the Reserve Bank Coinciding Indicator
Source: I-Net Bridge and Investec Private Client Securities
Two measures of the State of the SA economy 2007-2009
Source: I-Net Bridge and Investec Private Client Securities
The HNI and the Coinciding Indicator may be regarded as representing the rate of change of the economy or the first difference of the level of economic activity. When the economy is picking up momentum or accelerating, the indexes should point higher and when the economy is decelerating the indexes should point lower.
The second derivative – that is to say the rate of change of the rate of change – may provide a further indicator of the direction of the economy. However when we review the second derivative of the HNI, it does not suggest that the economy has begun to decelerate at a slower rate. In fact the economy, according to the HNI, appears now to be decelerating even faster than it was. We provide two measures of the direction of the HNI. One is the annual year-on-year change in the HNI and the other the monthly change in the HNI annualised. The monthly move in the index raised to the power of twelve suggests that the economy was deteriorating at a faster rate between August and October.
The HNI – The second derivative
Source: I-Net Bridge and Investec Private Client Securities
While vehicle sales are now declining at a slower rate (see below) the Real Note Cycle or what can be described as the real money base of the system, having tentatively recovered in September, turned down again in October (See below).
New vehicle cycle
Source: I-Net Bridge and Investec Private Client Securities
The real money base cycle
Source: I-Net Bridge and Investec Private Client Securities
The evidence suggests that domestic spending remains very weak. While GDP in the third quarter may have benefited from a less severe run down of inventories and an improvement in net exports, SA households and firms remain highly reluctant to spend more. And while they retain these inhibitions the economy will not be able to make much progress.
The Monetary Policy Committee of the Reserve Bank will be updating its evidence on the state of the economy next Monday and Tuesday under the direction of the newly appointed governor Gill Marcus. The weakness in domestic spending revealed by vehicle sales and the demand for and supply of cash, as well as the slow pace of revenue collected by the Treasury reported on recently, should ordinarily provide every reason for cutting interest rates and quantitative easing, as should the strength of the rand and the lower inflation accompanying the stronger rand.
A newly appointed governor might however prefer to wait and see how the economy evolves before taking any bold action. However any complacency about the ability of a global economic revival to lift the SA out of its current severe recession mire should be actively discouraged by the latest data.
The economy in Q2 2009: Mostly bad news, but bad news can bring improvement
What we already knew about the depressed state of the economy in Q2 2009.
We had been informed earlier by Stats SA that GDP, that is to say output growth, had declined further at a seasonally adjusted (-3.0%) annual rate in Q2 2009 for the third consecutive quarter making this a particularly severe recession. We also knew that the agriculture and particularly the manufacturing sector had suffered severe declines in production while mining sector output recovered showing positive growth for the first time in many quarters (See below). [Unless otherwise indicated all growth rates referred to in this report will be seasonally adjusted annual equivalent growth rates. All statistics and figures reproduced here are sourced from the Reserve Bank Quarterly Bulletin September 2009.]
The new bad news
Not at all surprisingly we are now informed that aggregate spending on goods and services by households declined at a further very depressing (-5.8%) rate in Q2. The weakest component of household spending remained spending on durable consumer goods, including new cars (down -18.8% pa in Q2), which had suffered so much at the hands of the increase in interest rates through 2006, 2007 and 2008 that had continued long after such interest rate sensitive spending was in precipitate decline (See below).
Does income drive spending or spending drive incomes?
It will be said that the severe decline in personal incomes caused the decline in household spending. Both decline at about a negative 6% rate in Q2 (see below).
The reality is that the decline in household spending that constitutes such a large part (well over 60% of GDP) caused the decline in incomes. Expenditure in aggregate drives income and output as much as the other way round. The problem for the SA economy, as it has been the problem almost everywhere, has been a lack of demand, especially for exports, as global spending collapsed in the face of the financial crisis. Almost everywhere else very active attempts have been made to stimulate domestic spending and its corollary bank lending to compensate for the weakness of foreign demand.
SA had led itself into recession with severe monetary policy settings that undermined household spending and left the economy especially vulnerable to the weakness of exports after the crisis broke. And SA is surely almost unique in the reluctance of its central bank to reduce interest rates and ease quantitatively to encourage domestic spending. The obsession of SA monetary policy with inflation and inflationary expectations, over which monetary policy has little influence, has left the SA economy well behind in the economic recovery stakes.
The failure of monetary policy revealed
The failures of monetary policy are well revealed by trends in broader money supply and credit growth. Both are now in absolute damaging retreat.
This is a most unsatisfactory state of affairs which the authorities should be addressing urgently with all the means at their disposal, including purchases of foreign exchange to add cash to the system and generous and extended terms on which cash can be offered to the banks. Without a recovery in bank lending the weakness of household spending and the economy must persist. None of this central bank action has been forthcoming. As far as we can observe of foreign exchange reserves held by the Reserve Bank, little attempt has been made so far to inhibit unwanted rand strength. The very strong rand has been draining the competitive strength of domestic manufacturing, which is facing a large deflation of the prices of imported goods with which they compete and of export prices and volumes realised in weaker offshore markets.
It is the corporate sector that has become debt shy
The weakest part of bank lending has in fact proved to be lending to the corporate sector though lending to households remains weak with mortgage lending growing very slowly (See below).
Clearly the decline in corporate borrowing is the result more of a lack of demand by business for capital to expand output than an unwillingness of banks to lend.
The sort of good news
We can explain why SA business has so little demand for bank credit in current circumstances and why in part this may be regarded as good news in that it does portend a recovery in the economy. Spending on inventories in Q2 particularly by manufacturers of motor vehicles declined at an extraordinarily rapid rate in Q2. Real inventories are estimated to have declined by an annual equivalent volume of R52bn in Q2. This is equivalent to a 10% reduction in Gross Domestic Expenditure (GDE), which is defined as the sum of Consumption and Investment Spending plus the change in the level of inventories held by the business sector. GDE is estimated to have declined at an extraordinary -14.5% pa rate in Q2. Final demands (spending net of inventory changes) declined by only -3.5% pa helped by relative stability in capital formation (see below).
Capital formation by business is demand derived from household spending- both are very weak
Gross fixed capital formation held up supported by further strong growth in capital formation by public corporations and despite a sharp further decline in capex by the private sector (See below). The weakness in household spending has naturally undermined the willingness of businesses to add capacity. The decline in private sector investment spending together with the sharp run down in inventories has clearly reduced the demands for bank finance. Only a revival in household spending helped by increases in the supply of bank credit can get capital formation going again.
Slower growth has led to a surprising reduction in the current account deficit
That GDE (-14.5% pa) declined as much as it did relative to GDP (-3.0%), allowed total output (GDP) to exceed total expenditure (GDE) for the first time since the economy took off in 2003.
By definition the difference between GDP and GDE is the difference between exports and imports. For the first time since the economy took off in 2003 the economy ran a trade account surplus in Q2 2009 and surprised many (including the currency market) with a significantly reduced current account deficit. This more than halved in Q2 and declined from the equivalent of 7% of GDP in Q1 to 3.2% in Q2.
This deficit is about equal to foreign capital inflows. The current account deficit is the sum of the trade balance and the balance of interest and dividend receipts from abroad. SA is a net remitter of interest and dividends equivalent to about 3% of GDP (See below).
The good news, if it can be regarded as good news, is that exports declined by less than imports in Q2 2009 as we show below.
Less invested=less imported
The cut back in investment in capital goods and finished goods on the shelves and in the production progress took a full toll of imports. The good news about inventories is that they cannot continue this rate of decline and that a smaller rate of decline will add to growth rates to come.
Hoping for better news about faster growth and larger capital inflows
It would have been much better news had both exports and imports demonstrated the strong positive growth rates of much of the period since 2003. The growth in the SA economy since 2003 was willingly supported by net inflows of foreign capital, hence the debt service payments (See below).
As may be seen the capital continued to flow through the global financial crisis when they might have been thought particularly vulnerable to this heightened risk aversion. However the inflows have slowed down with the slower growth currently under way.
The current account deficit that rise with growth rates and the capital inflows that finance the sum of the trade and debt service accounts of the balance of payments are two sides of almost the same thing. The almost part is the usually very minor change positive or negative in foreign exchange reserves held by the banks, which solves the balance of payments equation. Therefore without the capital inflows the current account deficit would have to be smaller and the growth rates constrained. Without foreign capital inflows, growth would have been slower; however without the growth the capital flows would not have been forthcoming.
Growth self evidently leads capital inflows – fear of the balance of payments is harmful to the economy
The dependence of capital inflows to SA on growth in SA is now very apparent. The growth slowed down and the current account deficit and the capital inflows declined accordingly. It cannot be argued that it was withdrawals of foreign capital that forced a slowdown in the economy. The contrary is surely true: the self inflicted slowdown in the economy was accompanied by less foreign capital demanded and so supplied to SA borrowers. This was the case through the worst global financial crisis since the great depression of the 1930s.
Much less fear of the economic future called for
Thus it can surely be argued that if SA growth picks up, foreign capital will be forthcoming to help fund the growth. There is surely no reason to fear growth on the basis that it makes the economy vulnerable to the dictates of foreign capital markets. It was such fears that led to the excesses of monetary contraction in 2006-7 that eventually produced the recession of 2008. A more sanguine attitude to the balance of payments would have avoided such excesses of monetary policy zeal.
There is every reason to encourage growth in SA because it will lead to capital inflows. As has been pointed out by Governor Tito Mboweni, a current account deficit is not inflationary. Or in other words capital inflows fund imports that add to the supply of goods and support the rand and so help hold down prices. Hopefully such an understanding will help the monetary authorities engage actively in helping the economy recover. But even if the positive feed back loop between growth and inflation is not recognised the desperate state of the economy revealed by Q2 expenditure will surely bring the Reserve Bank in from the sidelines.
The past as an irregular guide to the future
Grist for the Bears
Doug Short has attracted enormous attention to his website http://www.dshort.com/ with his “Four Bad Bear Market Analysis” (shown below and updated to Friday 28 August by its originator). The natural bears took great satisfaction from the apparently severe regularity of past bear markets, especially that of the crash of 1929. The problem for the bear lovers, as may be seen in the accompanying diagrams is that the relationship, especially with the bad bear of 1929-32, appears to have broken down in the face of the rally in stock markets that began in March 2009. The recent recovery appears by now to have extended for too long and too far to be identified as a bear market rally or a bear trap.
Source: dshort.com
If at first you don’t succeed….
This break in the data led the inventive Doug Short (his real name assuredly) to realign the starting point for the analysis and the apparent regularities from the top of the markets before they collapsed to the following bottom, when the markets began their recovery. This new version of the analysis provided by Mr Short that demonstrates that the bottom after the crash of 1929 “failed” eleven months later, no doubt provided renewed comfort to the bears. However as may also be seen the recent rally has also by now taken the Dow beyond its gains of 1929. A new attempt to find regularities in the stock market patterns may (bulls hope) soon be called for.
Source: dshort.com
Bull and bear markets are only revealed with hindsight
The reality is that bear and bull markets are only identified after the event. Daily share market movements are a random walk and recent events prove no exception to this as we show below. A bear market is one when the random drift proves, well after the events, to have been generally lower and a bull market is identified after the event as a period of time when the drift was mostly higher.
In the figure below we show the pattern of daily percentage movements in the S&P 500 and the JSE All Share Indexes since the lows in the market on 9 March 2009 until the market close of Friday 28 August 2009. In the further figure we show the distribution of these daily moves about its daily average of a positive 0.02% per day with a large standard deviation of as much as 1.6% per day. The equivalent statistics for the S&P 500 are an average move of .03% per day with an even larger standard deviation of 1.7% per day. If we take the period back to the peak of the markets in May 2008 the average daily price move for the S&P 500 since then is a negative .09% per day and -0.06% per day for the JSE.
Daily percentage moves in the S&P 500 and the JSE ALSI since 9 March 2009
Source: I-net Bridge and Investec Private Client Securities
Histogram and Descriptive statistics for daily moves in the JSE ALSI March-August 2009
Source: I-net Bridge and Investec Private Client Securities
Beating the market demands careful judgment about the forces that will drive and surprise the markets
Predicting whether the continuous random drift in market indexes and share prices will be higher or lower calls for fundamental judgments about the information flows that will move the market over the following twelve or more months. The past provides us with our theories about the forces that drive markets – our theories then lead us to anticipate and predict the direction of the economic fundamentals that we believe will surprise market participants and lead the market to drift higher or lower in the course of the next twelve months or so. We have to make these predictions with humility about the difficult nature of the task of beating the well informed market.
Mining past moves in stock market indices for patterns that will repeat themselves in the future is often attempted, but in our judgment such attempts are unlikely to prove reliable in a consistent way.
How much demand led inflation is there out there?
A stubborn CPI – until you look deeper
Inflation in South Africa (6.7% in July down marginally from 6.9% in June 2009) might well be regarded as stubbornly high given the weakness of the SA economy and especially of aggregate demand. The Consumer Price Index (CPI) actually increased by as much as 1.1% in the month that if sustained would lead to an annual rate of inflation about 14%. However it hopefully will be noticed by the monetary authorities that almost all of the increase in prices in July can be attributed to increases in the charge for electricity to households and the increase in the costs of private transport.
Supply side shocks continue to drive the CPI higher
These are areas of the economy where prices are set by officials and regulators rather than market forces and are therefore not susceptible to monetary policy. These administered or regulated prices, especially electricity and water charges, are playing rapid catch up with the costs of adding to capacity to supply more such essential services. This adjustment has come after years of excess capacity and prices being regulated by reference to historic rather than replacement costs. Hopefully these supply side shocks to prices are temporary ones that end when replacement cost pricing is established. In the market place, if firms cannot realise prices that cover replacement costs – and provide a satisfactory return on capital invested – they go out of business. Publicly owned utilities with monopoly power do not go out of business – they charge higher tariffs and are infused with additional capital supplied by the tax payer.
Higher charges lead to less spending – not more inflation
Households cannot avoid paying these higher charges and this makes them less rather than more capable of spending on other goods and services. This adds to the deflationary pressure currently acting on prices that are market determined. Such forces would normally – absent of inflexible inflation targets – call for lower rather than higher interest rates to encourage more spending so badly needed to lift the economy out of recession. These deflationary forces will be revealed in gory detail when lower prices realised at the farm, factory and port gates come through in the Producer Price Index (PPI) for July, to be updated today. PPI is expected to be more than 4% lower than twelve months ago. The threat to the SA economy as most economies world wide has been and remains deflation and recession not an inflationary boom.
Looking at the CPI in detail
In the calculation of the CPI the largest weight by far (22.7%) is given to the broad category Housing and Utilities. The prices of Food and non-alcoholic beverage that account for 15.68% of the Index actually fell 0.4% in July reducing the year on year change in Food and Beverage prices (Food Inflation) to a still above average 8.3% pa. Yet it has now become clear that lower prices at producer level are feeding into lower prices for consumers. The weight attached to the electricity and other fuels account is but 1.87% and to water and other services 3.31%. However the increases in electricity and water charges in July were extraordinarily high – as much as 21.5% for electricity and 8.8% for water.
Thus the monthly increase in electricity charges contributed 0.4% of the July month increase of 1.1% and higher water charges contributed another 0.29%. The increase in Private transport costs – mostly fuel – contributed 0.20% leaving all other items with an average monthly rate of increase of 0.11% – a very low rate of inflation. Thus almost all of the increase in prices in July can be attributed to prices that are beyond the influence of consumer spending and beyond the direct influence of monetary policy and interest rates.
Whither owners equivalent rent – the key to inflation to come
The largest component in the important housing cost category is Owners Equivalent Rent with a weight of 12.21% of the CPI. This item has replaced mortgage interest in the CPI and takes its cue form average house prices of which implicit rents are some assumed fraction. Owner equivalent rent is the statistician’s equivalent of the accountant’s mark to market adjustments that has no direct impact on cash flow but can be just as confusing in its implications.
Unlike when mortgage interest rates rise or fall and add or reduce measured inflation, as used to be the case in the calculation of headline CPI, households are likely to spend more when their wealth increases with higher house prices and a higher CPI and vice versa: spend less when house prices and owners equivalent rent is falling. The task of dealing with asset price inflation – especially house price inflation – has proved beyond the capabilities of central bankers. Asset prices are now a direct influence on the SA inflation rate and will need especially careful treatment when inflation targets are being aimed at.
Owner equivalent rent did not change in July – presumably because (declining) house prices were not sampled in the month. Actual rentals (weight 3.49%) also recorded a zero change for presumably the same reason. Presumably lower house prices when surveyed will help lower owner equivalent rents and measured CPI inflation.
The problem is recession and deflation – not inflation. Will the Reserve Bank act accordingly?
The direction of prices that have been influenced by monetary policy and interest rates is decidedly downwards and is currently still adding to the recessionary pressures acting on the economy. What is required is a full recognition by the Reserve Bank of these facts of SA economic life. The Reserve Bank needs to take a leaf from the play book of most other central banks that cut interest rates sooner and much more aggressively and eased quantitatively – that is printed more money – because they recognised the immediate deflationary and recessionary dangers to the well being of their economies posed by the global credit crisis. This recognition in SA has been far too long in coming – confused as it should not have been by very different signals emanating from the direction of consumer and producer prices. Hopefully the epiphany is upon us.
Interest rate cut: A well received surprise for the market place
The 50bps reduction in the Reserve Bank Repo rate came at a distinct and welcome surprise to the market – a surprise that saw the forward short term rates and long term bond yields decline significantly. The implicit inter bank rates (JIBAR) three and six months forward rates declined by about 40bps as did the Forward rate Agreement (FRA) curve as we show below. The six month JIBAR forward rates remains above the three month rate and the FRA rates remain above the JIBAR rates, indicating that banks are paying up for longer term money. We were correct in arguing that the Bank could not ignore the further deterioration in the SA economy.
SA Banks Forward Rate Agreements
Source: Bloomberg and Investec Private Client Securities
JIBAR Forward Rates
Source: Bloomberg and Investec Private Client Securities
That the long term yield remains flat indicates that the market believes that interest rates are likely to remain at current levels for an extended period of time. The implied one year rate in ten years time is little different from the current one year rate.
The RSA Yield Curve
Source: Bloomberg and Investec Private Client Securities
The rand was unmoved by lower interest rates
The trade weighted rand was largely unmoved by the surprise reduction in interest rates. The decline in long term yields saw inflation compensation in the bond market, the difference between vanilla bond yields and their inflation linked equivalents, decline marginally. The yield on the inflation linked R189 also declined.
RSA Bond yields and inflation compensation
Source: Bloomberg and Investec Private Client Securities
Trade weighted exchange rate (higher values indicate weakness)
Source: Bloomberg and Investec Private Client Securities
The market reactions make the point – more than inflation targets are called for – for lower inflation
Such favourable reactions in the money and currency markets and of inflation compensation should encourage the Bank to continue to look beyond inflation as the focus of its operations. The weakness of the domestic economy remains the threat to the ability of the economy to attract foreign capital to support the rand and help hold down inflation. The economy, despite the SA recession, continues to attract foreign capital at an extraordinary rate as capital has flowed into emerging equity and bond markets, commodity markets and resource companies on recovery prospects. The SA markets have received their share of these flows – hence the strong rand that has held its own against strong other emerging and commodity market currencies.
Much more than lower interest rates are called for to help the economy
Lower interest rates can help support the longer term growth outlook and the attraction of the SA economy to foreign and local investors. But much more than lower interest rates are called for if the SA economy is to compete effectively with other emerging and commodity market destinations for capital over the next year or two. Quantitative easing, that is an increase in the rate of growth of central bank cash supplied to the system, is called for urgently to encourage the banks to lend more freely especially to households. The grave weakness in household consumption spending has to be overcome if the economy is to prosper. We have called for the Reserve Bank to supply one year money to the banks of which they continue to appear short. We would repeat this call with greater urgency.
We also welcome any temporary increase in the fiscal deficit. This is the time for the SA government to put its strong balance sheet to work to help the economy and tax revenues to recover. Hopefully stronger markets for SA exports will also assist the recovery.
The economy: Every reason to lower interest rates and to ease quantitatively
The Hard Number Index points lower
There is little comfort to be found about the current state of the SA economy in our Hard Number Index (HNI) for the SA business cycle that has been updated to July 2009. The HNI declined further from 129.48 in June to the current reading of 127.07 (2000=100). The direction of the index, its rate of change or the second derivative of the business cycle, suggest that the time when the rate of decline starts to level off is at hand though the prospects of positive growth seems some way off.
No pick up in vehicle sales or growth in the supply of cash
The HNI is an equally weighted combination of two very up to date indicators: vehicle sales; and the notes issued by the Reserve Bank, adjusted for consumer prices to provide a measure of the real money base. Both indicators are hard numbers, rather than based on sample surveys, and they are updated to the July month end. Neither series is showing improvement. The growth in the supply of cash to the system continues to slow marginally while new vehicle sales remain well below year ago levels and this deeply negative rate of growth (-40%) has not yet become obviously less negative.
The consolation to be found is in the influence of less inflation on the real supply of cash. The real money base is trending to barely positive growth.
Relief urgently called for
This data would ordinarily make it ever more obvious that the SA economy derives all the help it could get from easier monetary policy. Lower interest rates, combined with quantitative easing, both of which are active steps designed to increase the supply of cash to the banks (who are proving so reluctant to lend) are even more urgent now than they were six months ago.
The reluctance of the Reserve Bank to do what almost every other central bank has been doing to ease the pain of recession has been very difficult to appreciate. We have explained why the Bank’s concern for inflationary expectations is not sensible in these unhappy circumstances when the gap between actual and potential output of the SA economy has widened so damagingly and when prices at the factory farm and port gates as measured by the Producer Price Index (PPI), are falling so sharply. We argued that inflationary expectations were rising because it had become apparent that a change in Reserve Bank leadership was inevitable given its lack of flexibility and that more inflation tolerant policies might be adopted.
Plus ça change?
The change in leadership to come has since occurred with the prospect that low inflation over the long run will remain a primary concern of the Reserve Bank. However hopefully not regardless of the state of the economy and with attention focused only on consumer prices, which are particularly insensitive to the state of demand in the economy over which the Bank exercises its influence.
Less inflation now expected
Inflation compensation offered in the RSA bond market, being the difference in yields on offer between conventional bonds and their inflation linked equivalents have moderated recently. This is the most objective measure of inflation expected. Another measure of inflation to come is the expected direction of the rand over the long run. The difference in RSA and USA long bond yields indicates break even rand depreciation expected. That is in equilibrium the differences in nominal yields will be expected to be eliminated by a weaker rand. Thus the wider the difference in such bond yields the more rand weakness expected and so the more SA inflation on average will be expected to exceed average inflation in the US over the long run. This measure is also indicating less weakness for the rand now expected over the long run.
Ever more reason for easier monetary policy – will reason prevail?
There is therefore even more reason for lower short term interest rates in SA now than there was in June 2009. The economy has weakened further, pricing power of producers is clearly suffering further and the administered price dominated and recalibrated CPI is also rising at a slower rate than it did earlier in the year. Furthermore inflation priced into bond yields is now less than it was.
Can even the Reserve Bank with its lame duck leadership resist this evidence? We think not and expect a (surprising to the market) 50bp cut in the repo rate.
A New York state of mind: Some judgments about the economic and financial state of play
Financial markets have normalised. Much of the dislocation has been resolved – and the more obvious opportunities provided by dislocated markets have to a large degree been exercised (think of recent moves in sovereign bonds, corporate bonds, bank credit, emerging equity markets). Equity market volatility has subsided.
The US economy will come out of recession in H2 2009: positive growth will be achieved and is well under way. Preliminary Q2 estimates of GDP will be released on Friday. Even the housing market has turned with sales of new houses off their bottom. Yesterday’s Durable Goods number – excluding volatile aircraft orders – was a good number. Such a view of recession being over is not contentious but is now consensus.
The normal forces of economic growth and earnings growth surprises (up or down) therefore take over as the main drivers of equity and bond markets. Higher short and long term interest rates – while a sign of recovery under way – will not be welcome.
The key issues will be the pace of US recovery, V or U shaped – and even it is V shaped (driven by depressed output catching up with stable final demand) – the question that will be asked of the US is: can such fast growth be sustained over the next few years? That the US recovery is ahead of Europe’s should be helpful to the US dollar/euro rate of exchange.
The answer to this issue about the long term growth potential of the US economy is for observers to expect less long term growth. Given the state of fiscal policy, higher taxes and more intrusive government will be expected to restrain growth. The ability of the Fed to withdraw the punch bowl before the party gets raucous will remain a live one – inflationary expectations remain very low and explicit real interest rates remain depressed. The bond market vigilantes are sleeping soundly at home for now. Any inflation threat to bond yields and mortgage rates will be most unwelcome but always possible. Corporate bonds remain more enticing than government bonds.
Emerging market economies offer a much healthier prospect, but their equity markets have run very hard, as have their currencies. The EM index and the JSE ALSI in US dollars are both up 80% from their lows in early March and the rand is up there with the best performing EM and commodity currencies. This is a very powerful run indeed. China has led the way and possible oriental bubbles will be of concern.
The SA economy continues to languish without active enough assistance form monetary policy. But the better state of the global economy will be helpful to SA exporters. Lower inflation and the strong rand will be helpful for consumers.
Reserve Bank Governor Tito Mboweni’s decision not to lower rates in June can perhaps be regarded as a final act of defiance. Knowing (presumably) that he was to lose his job he stuck to his inflation target guns even as his ship was sinking. He had failed to seize his opportunity to save the economy with an activist programme. Even as central bankers elsewhere put on the Superman capes he remained aloof as if all that mattered was inflation. This was not only arguably an error of judgment but obviously very poor survival tactics.
The case for lower interest rates remains as strong as ever and if Gill Marcus is in the next MPC chair – one assumes she will be – she will surely wish to distance herself from her predecessor. They apparently did not get on at all well when she worked at the Bank as Deputy Governor and resigned accordingly.
There is in this author’s mind at least a 50% chance of a 50bps cut at the August MPC meeting; and if August is too soon to signal change in direction of monetary policy then there is a much greater chance of a cut, perhaps even a 100bps cut, at the following meeting. The money market is not expecting any change in rates for now – or at least wasn’t yesterday. Watch this space.
*The author wrote this piece while on a visit to the US
The Reserve Bank has no more to offer
The Reserve Bank has indicated very clearly that it does not intend to provide any further relief for the hard pressed SA economy. Neither lower interest rates, nor quantitative easing, is on offer for the foreseeable future.
The Reserve Bank is relying on waiting to quote its release:
“….There are however signs that the downturn, both globally and domestically, may be nearing the lower turning point, but the recovery is expected to be slow and protracted…”
It added later that:
“….The composite leading indicator as compiled by the staff of the South African Reserve Bank increased slightly in April. The indicator suggests that the lower turning point in the cycle could be reached later in the year.”
We would agree that while the global economy may well have reached its lower turning point, we are not at all sure that the SA economy has done so. We do not share confidence in the predictive powers of a leading indicator much influenced by the stock market. The housing market is probably more important than the stock market in influencing the wealth and confidence of the SA consumer and trends there are not at all helpful.
The economy is very dependent on global trends
The reluctance to lower interest rates further or to engage in quantitative easing
(linked to attempts to restrain rand strength) has made the recovery of the SA economy dependent on global trends. The outlook for domestic spending remains bleak as the Reserve Bank has confirmed.
Unintended consequences
In response to the decision the rand responded favourably to the prospect of higher short term rates while higher long term rates followed short rates higher.
The compensation for inflation offered in the bond market, being the difference between the yields on the inflation linked government bonds and the vanilla variety (to which the Bank gives attention in its focus on inflationary expectations) rose yesterday. The yields on the inflation linkers declined reflecting the poorer growth outlook while the nominal yields rose.
A stronger rand and higher interest rates are surely not desirable outcomes of monetary policy settings. The stock market and also the exchange value of the rand however are responding to forces beyond the influence of SA monetary policy. The stock market is largely ignoring the deteriorating outlook for the earnings of SA economy dependent companies.
Global forces dominate the rand and the JSE
The dominant forces acting on the JSE and the rand are the direction of Emerging Equity Markets and commodity prices – they are running together in response to the outlook for the global economy. This outlook has improved significantly over the past few days in response to OECD economic forecasts that were revised higher rather lower.
The Reserve Bank is fighting inflationary expectations
The focus of the MPC statement was on inflation and inflationary expectations. The Reserve Bank argument against lowering interest rates is a familiar one. That is to contain inflationary expectations – even while recognising that the weak state of the economy – may well lead inflation lower. They also make reference to producer prices that are falling sharply and that unlike consumer prices, do decisively reveal the weak state of domestic demand as well as the influence of the strong rand on the competition for domestic producers. That producer prices might better reflect the thrust of monetary policy and that if they do, deflation may be a greater threat to the economy, does not receive consideration.
Are inflationary expectations self fulfilling?
The Reserve Bank is of the view that inflationary expectations are self fulfilling, even if the economy is suffering form excess supply rather than excess demand. The long run benefits of less inflation expected and therefore less inflation – as it is assumed – is thought to be the worth the short term sacrifices the economy has to make.
How the Reserve Bank could hold to this view now given producer prices, is very hard to appreciate. Our view is that inflationary expectations, when applying some naïve cost plus view of price determination, can only lead to permanently higher inflation when supported by a willingness of consumers to spend more.
The current unwillingness of SA consumers to pay more is obvious. The Bank also is well aware that the pressures on consumer prices are coming from prices that are regulated rather than market determined – and therefore well beyond the direct influence of monetary policy. Such price increases however act as a tax on expenditure and depress demands for less dispensable goods and service. Tax increases provide reason for lower rather than higher interest rates.
An alternative explanation for more inflation expected
The Reserve Bank might however consider another reason for the unhelpful trends in inflation expected, other than inflation trends themselves. That is a single minded focus on fighting inflation- in rhetoric perhaps more than in practice – is politically unsustainable. If so this is expected to damage the independence of the Reserve Bank to continue its fight against inflation over the long run. Apres moi le deluge is not an unrealistic conclusion, one leading to more inflation expected over the long run.
We share the view that low rates of inflation are helpful for economic growth in the long run. But to regard inflation as the end rather than the means of economic policy regardless of the state of the economy, is neither necessary or helpful to the cause. The decision of the Reserve Bank not to lower interest rates now will add doubts as to the usefulness of low rates of inflation when the sacrifices for it seem so heavy and do not make obvious sense. The political consequences of Reserve Bank inaction are not necessarily encouraging for the inflation outlook.
Monetary policy: How much room for manoeuvre?
Asking the right questions
The Monetary Policy Committee of the Reserve Bank will be asking this question of the economy today and tomorrow. They will be well aware that despite a severe decline in household spending (household spending declined at a real 4.9% rate in Q1 2009) net flows of capital to SA continued at near record rates, equivalent to 7% of GDP. All other things remaining the same, had spending growth been anything like normal, the flows of capital from abroad would have to have been even greater.
Avoiding the wrong answers
Perhaps it will be suggested by committee members that it would be unrealistic to expect capital flows of larger orders of magnitude – so limiting severely the scope for more household spending – and by implication the scope for lower interest rates that are urgently called for to encourage households to spend more and banks to lend more. We will argue that this would be the conclusion to draw from what is an inappropriate line of enquiry. Such thinking has caused the economy unnecessary distress in the recent past.
These are not normal times
Normally such a severe reduction in spending as occurred in Q1 2009, would have led to fewer goods and services imported, an improvement in the balance of trade and so less capital imported. The problem however was that the volume of exports declined at an even faster rate than real imports in Q1 – the result obviously of the global recession that reduced in particular demands for metals, minerals and motor cars from SA. The weaker trade balance dragged down GDP, which declined at a very depressing 6.4% rate in the quarter.
Spending in general held up in Q1 2009
However not all categories of domestic spending were in retreat in Q1. Surprisingly and somewhat anomalously, household spending on services actually grew at a brisk 7.5% rate amidst the consumer gloom – implying that spending on consumer goods will have declined at an over 12% annual rate. Gross fixed capital formation continued to increase, though at a very sedate pace compared to a year before, and government consumption spending also rose marginally.
Final demands, being the sum of household and government consumption spending and fixed capital formation, declined at only a net 1.5% rate. The disinvestment in Inventories of -R10.2bn, half the decline estimated for Q4 2008, meant that Gross Domestic Expenditure actually grew at a 2.2% annual rate in Q1 2009. (See the tables below sourced from the Quarterly Bulletin of the SA Reserve Bank June 2009)
Spending held up as did capital inflows and prices came down
Thus aggregate demand in general held up much better than aggregate output and this was made possible by robust capital flows. These capital flows also helped to strengthen the rand and by so doing lowered the rand prices of imported goods and services including capital goods. Without these more favourable trends in the prices of goods, particularly at the ports and the factory and farm gates, spending presumably would have been even weaker.
Guesses about the pace of capital flows have been wrong and may continue to be wrong
Trying to second guess the ability of the SA economy to attract capital and to set monetary and fiscal policy accordingly is in our view quite the wrong way to steer the SA economy. Yet such concerns have been an important and unhelpful influence on monetary policy in the recent past. They led to a much weaker rand in 2006-7 as higher interest rates came to threaten the growth outlook for the economy.
The guesses about the attractions of the SA economy to foreign capital are very likely to be wrong ones. Such guestimates have almost certainly underestimated actual capital flows to SA in recent years. They have not taken into full account the favourable feedback loop from faster growth to increased flows of capital into account. If growth can be kept going with sympathetic monetary policy settings, that emphasise the objective of sustaining growth, more capital can flow in to make that growth possible. And more capital means a stronger rand and less rather more inflation to accompany faster growth. That the SA economy could attract net foreign capital flows, at the rate equivalent to 7% of GDP in a recession as it did last quarter, would have been inconceivable to balance of payments model builders.
The conclusion the MPC should come to
The conclusion we believe the MPC should come to about its room for manoeuvre is to do all it can to revive household spending. Lower interest rates combined with quantitative easing is called for. If this should however mean a weaker rand because the extra foreign capital is not forthcoming this would mean a weaker rand and so be it. This would unfortunately mean higher prices and counter the stimulatory influence of lower interest rates.
Do not second guess the rand
The rand however should not be the objective of policy either directly, when the Reserve Bank intervenes in the currency market, or indirectly when it makes judgments about the sustainability of capital flows and sets interest rates accordingly. The rand should be allowed to find a value that is consistent with achieving a good balance between potential and actual domestic output. This is the only proper goal for fiscal and monetary policy with low inflation seen as a means to this end rather than an objective of policy itself.
The rand as we have indicated may well stand up well if faster growth were achieved and so more capital is attracted. The Reserve Bank should never feel constrained by fear of capital flows when encouraging domestic spending providing such spending is insufficient to the purpose of maintaining potential output and employment.
Realism called for
Yet the MPC will have to be realistic about how much influence it can have today on the economy. Any immediate revival in domestic spending growth is unlikely even with lower interest rates and quantitative easing. The confidence and wealth of SA households have suffered too much recent damage to expect any immediate response. Paradoxically even if the MPC does not share our view of the world the thought that spending is unlikely to revive soon will encourage the Committee to lower interest rates.
Therefore the relief for GDP growth is much more likely to come from exporting into a reviving global economy than from household spending. We expect the MPC to cut its repo rate by 50bps and by another 50bps in July. Any deeper cut now would be very welcome to us and the markets.
The SA Business Cycle: Hard numbers still pointing to lower levels of activity
Our Hard Number Index (HNI) can now be updated for May 2009 with the release of two hard numbers, vehicle sales and the notes issued by the Reserve Bank at May month end. As we show below there is no sign of any improving trend in the SA economy to be derived from the HNI. The Index attempts to replicate the pace of growth – higher numbers indicate that growth is picking up momentum that is accelerating while lower numbers indicate that growth is slowing down.
The HNI peaked in late 2006 at a value of over 165 indicating that the economy was then moving ahead at a very rapid rate. The latest reading for May 2009 is 106.06 and down from its 109.06 reading in April. This indicates that not only has the economy slowed down but that it is in now in reverse and probably going backward more rapidly than earlier in the year.
The HNI may be regarded as representing the first derivative of the economy. The second derivative, that is the rate of change of the rate of change in economic activity, is still pointing lower indicating little sign of a bottoming out in the pace of economic activity.
The Hard Number Index May 2009
Source: Investec Securities
The SA Business Cycle – The second derivative
Source: Investec Securities
New vehicle sales are still in decline
Vehicle sales in May provide very little cause for comfort that interest rate sensitive spending is responding to lower interest rates. The growth measured as the change in vehicles sold in May 2009 over May 2008 showed a further decline compared to April growth. More discouraging is that the underlying trend in vehicle sales is still pointing down rather than up. We calculate this trend by smoothing vehicle sales and then annualising the monthly growth in this smoothed measure.
Growth in New Vehicle Sales
Source: NAAMSA, Investec Securities
Not all bad news – the money cycle is pointing up
It is fortunately not all bad news. There is some consolation to be derived from the latest trends in the cash, that is Reserve Bank money supplied to the SA economy. Adjusted for the inflation trend, we can now observe an improving trend as may be seen below. Annual growth has turned marginally positive and the underlying trend has improved suggesting that a sustainable recovery in the supply of cash is under way. The driver of this series is lower inflation rather than any pick up in the cash supply itself as we also show. The growth in the actual cash supply (not adjusted for inflation) has been trending marginally lower as may be seen.
The real money supply cycle
Source: Investec Securities
The cash cycle
Source: Investec Securities
Is the Bank undertaking quantitative easing?
In this regard it is to be noted that the gross foreign exchange reserves of the Reserve Bank increased by a large US$1.724bn in May 2009. This indicates that the bank was very active resisting rand strength last month, notwithstanding the recent remarks from the Governor about intervention in the currency market. Of greater interest is that these purchases to not appear to have been sterilised by treasury open market sales of government securities.
The government deposits at the Reserve Bank that would indicate such operations actually fell in May to R66.153bn from R66.402bn in April. This may indicate that the bank and the treasury agree with us that quantitative easing, that is supplying the banks with more cash via operations in the currency market, to encourage them to lend more freely, is a good idea, given the weak state of the economy. A recovery in the supply of money and bank credit is essential to the purpose of reviving the SA economy.
No room for complacency about the state of the SA economy – aggressive policy action is called for
Grim news from the shop keepers
Retail sales statistics were updated yesterday 13 May. The state of the retail sector in March 2009 provides no comfort at all about the state of the SA economy. The statistics indicate that sales adjusted for inflation are still falling at an accelerating rate. Interpreting retail activity is always complicated by the Easter holidays that may come in March or April, as they did this year. We will need to wait for the April numbers to fully adjust for Easter.