Yellen: Why, rather than when

FX

Yesterday, Fed Chair Yellen addressed the Economic Club of New York on the subject of “Monetary Policy and the Economic Recovery”. While her prepared remarks did not reveal anything new or significant regarding the Fed’s policy normalisation plans, she did provide some clarity on the reasoning, views and intentions behind the Committee’s actions. She reiterated the view that, while a great deal of progress had been made in the labour market, there still appeared to be a significant degree of slack. As this slack closes, she said, “it will be necessary for the FOMC to form a more nuanced judgment about when the recovery of the labor market will be materially complete”. Hence the need to base decisions and views on “a wide range of indicators”. On inflation, and specifically the likelihood of it moving back to the Fed’s 2.0% objective, she mentioned two considerations that the Committee deemed important in this assessment. The Committee anticipates that, “as labour market slack diminishes, it will exert less of a drag on inflation”. However, she added that the Committee has noted that during the recovery, the significant degree of labour market slack has “not generated downward pressure on inflation”, or at least not to the extent that would usually be expected. Consequently, the Committee must remain vigilant, she said, “to see whether diminishing slack is helping return inflation to our objective”. The second consideration is that the Committee’s confidence that inflation will return to its long-run objective is contingent on the view that inflation expectations anchored near 2.0% will “provide a natural pull back to that level”. However, the Committee is uncertain about “the strength of [this] pull in the unprecedented conditions we continue to face”, and this is something it will “continue to assess”, she said. Yellen also noted that the Committee is aware that inflation could rise materially above the target. However, at this stage she “rate[s] the chances of this happening significantly below the chances of inflation persisting below 2 percent”.

US industrial production data, out yesterday, came in stronger than anticipated, rising 0.7% m/m for the month of March against a consensus forecast of 0.5% m/m (Bloomberg consensus). In addition, the weather-affected February reading was revised significantly upwards to 1.2% m/m from 0.6% m/m. Steve Barrow (our G10 Strategist) points out that this adds to some of the revised data we've seen recently that suggests Q1:14 GDP might not be as soft as many had originally thought. The possibility of a stronger than expected US recovery, while good for EM export prospects, could pose challenges for capital flow dependent emerging markets like South Africa if it implies that Fed monetary policy normalisation could occur at a faster pace.

In China, the State Council has announced that the government will lower the deposit reserve requirement ratio (RRR) for qualified rural commercial banks and rural cooperatives. Rural commercial banks account for a very small portion of China's banking system, which means that this is far less significant than a system-wide cut in the RRR would be. Consequently, we would not view this as a deviation from the PBoC’s plans to tighten credit conditions, which entail measures aimed at clamping down on inefficient and expansive lending practices. The State Council didn't give any details of the reserve cut, but Jeremy Stevens (our China-based Economist) points out that a 50 basis points cut would release approximately CNY25 billion into the banking system, which is a fraction of a CNY500 billion liquidity injection that would correspond with a RRR cut for all banks. Lowering the RRR is typically used to boost bank lending, Jeremy says but, much like the recently announced fiscal support for the railway sector and urban development, this latest move (a marginal one at that) is really about managing sentiment.

As expected, growth in retail sales slowed in February. It dipped to 2.2% y/y from a revised 6.4%y/y in January in response to higher inflation and slower growth of household credit, notes SBGS Economist Kim Silberman. Base effects also acted downwards on the y/y change. Goods price inflation, as measured by the ratio of current to constant retail sales, kept rising, to 4.2%y/y from 3.8%y/y in January. YTD, the underperformance of cyclical consumer goods versus more defensive categories such as food and clothing, continues to play out, and is keeping with our macro-economic outlook of a slowdown in cyclical GDP. YTD retail sales are running pretty hard (4.2% y/y) when compared with annual growth in 2013 (2.7%. However, we anticipate a moderation in this momentum on the back of the macroeconomic headwinds from lower real wages as well as tighter monetary policy. The deceleration in retail sales growth was broad-based in February. Starting with the non-durables retailers, general dealer sales growth dipped to 1.1% y/y from 6.6% in January; food, beverage and tobacco sales contracted by 3.8% in February following an increase of 4.6% in January. Growth of clothing and footwear sales remained buoyant at 10.4% y/y in February, but this nevertheless represented a deceleration compared with the 11.2% registered in January. The contraction in sales of furniture and appliances eased to -2.5% y/y from -3.4% in January. Durable goods retailers continue to bear the brunt of poor consumer confidence. Retail sales growth of hardware, paint and glass slowed to 4.2% y/y from 9.9% in January; trends tracked those of pipeline residential construction activity, which also took a dip in February. Retail sales of all other retailers, which includes sellers of jewellery and watches, books and stationery, second-hand goods and repairs of personal and household goods, contracted by 2.7% y/y after a rise of 2.5% in January.

The rand weakened for the fifth consecutive day against the dollar yesterday, closing at USDZAR10.57 compared with Tuesday’s close of USDZAR10.56. This occurred into a mixed performance from the dollar against the major crosses, a mostly weaker performance from commodity currencies and a mixed performance from the EM currencies we track for purposes of this report. The dollar weakened against the pound and the euro, while strengthening against the yen. The rand weakened against the dollar, the euro and the pound, while strengthening against the yen. All but one of the commodity currencies we track weakened on the day, the exception was the AUD, which strengthened slightly. Four of the nine EM currencies – namely, the ZAR, the IDR, the INR and the BRL – we monitor weakened on the day. The rand was the second-best commodity currency and occupied a middle to lower position in the EM currencies category. The rand traded between a low of USDZAR10.5113 and a high of USDZAR10.5861. Support from where the rand opened this morning sits at 10.4800, 10.3500 and 10.2500. Resistance levels sit at 10.5600, 10.6800 and 10.7400.

Turning to commodity prices, copper and Brent rose by 1.2% and 0.8% respectively. Platinum and gold meanwhile fell by 0.1% and 0.01% respectively. The ALSI rose by 0.7% and the EM MSCI fell by 0.3%. The EMBI spread compressed by 5 bps and the SA’s five-year CDS spread compressed by 7 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 9.2%.

Non-residents were mild net sellers of local equities (-ZAR85 million), but were net buyers of local bonds (ZAR659 million) on the day. Buying of bonds was seen in the 3-7 (ZAR403 million) and 12+ (ZAR332 million) year buckets. Selling of bonds was meanwhile seen in the 1-3 (-ZAR70 million) and 7-12 (-ZAR7 million) year segments. The R203 and R214 yields fell by 3 bps and 1 bp, respectively. The R208 and R186 yields were unchanged. The 3-month Jibar rate increased by 2 bps from 5.75% to 5.77%. The 3x6, the 6x9 and 12x15 FRAs all fell by 2 bps.

Amplats, Implats and Lonmin will meet with AMCU today to continue discussions aimed at resolving the dispute that began on 23 January 2014. Charmane Russell, spokeswoman for the platinum producers, indicated yesterday via email that “further discussions with the AMCU will continue”. Johan Theron, Implats spokesman, said “[t]he employers explored various options with AMCU and resolved to formally respond.” Joseph Mathunjwa, AMCU president told reporters on Tuesday that strikes would continue “for as long as the companies refuse to improve their proposals.”

FI

The bond market continues to see low turnover, as we enter the start of four public holiday-shortened weeks in South Africa. Yesterday had turnover of ZAR13.2bn in SAGBs, with only the R186 (ZAR5.78bn) and R209 (ZAR2.27bn) seeing more than ZAR1bn in turnover. This came as offshore was recorded as net buyers of +ZAR626.29m of nominal SAGBs and net sellers of –ZAR32.68m of ILBs. The 3-7 year bucket was net bought for +ZAR403m and the 12+ year bucket net bought for +ZAR333m. Large purchases were seen in the R208 (+ZAR337m), R213 (+ZAR210m), R214 (+ZAR170m) and R2048 (+ZAR186m). The R186 was the only bond heavily sold for -ZAR393m.

The belly of the curve saw little, if any, yield moves, while the front and back end of the curve rallied. This caused the front end of the curve to bull steepen and the back end to bull flatten. 3m Jibar ticked up very slightly to 5.767%, from 5.750%, arguably due to funding reasons. FRAs followed the front end of the bond curve, rallying slightly. The FRA market is now pricing in a slightly less than 100% probably of a 25 bps hike at the next MPC meeting, while 50 bps of tightening is priced within the next 4 months, with 100% probability. Tomorrow, the 3x6 FRA will move over the July MPC meeting, so we expect that point in the FRA curve to move slightly higher when the market reopens on Tuesday.

Sanral returned to the local market yesterday, for the first time since 2011. The road agency aimed to issue up to R600m of debt at its auction, ultimately issuing R500m of debt from over R1bn in bids. R105m was issued in the fixed-rate HWAY20 at R207 + 55 bps and R315m of HWAY34 at R209 + 68 bps. While R66m of the inflation-linked HWAY23 was issued at R197 + 29 bps and R14m of the HWAY24 at R197 + 30 bps. All the tapped bonds are government guaranteed, with concerns about the agency’s ability to issue its unguaranteed NRA* bonds. The agency expects to hold its next auctions on 21 May and 1 June.

S&P released a report yesterday stating that the Turkish and South African banking systems are most vulnerable during fed tapering. The rating agency has previously said that they expect emerging markets to undergo periods of volatility and instability during this time. They felt this was particularly the case for those countries with large current accounts or foreign debt exposure. While the Turkish banking system has large levels of foreign external debt, banks there have managed to refinance all debt in Q1:14. The South African banking system has little external funding worries, as banks here have little foreign borrowing. While the agency expects growth in South Africa to be low in 2014, the risk to the country is more from its large current account deficit. This has recently been financed by relatively volatile portfolio flows and the rating agency is concerned that a capital flow reversal, under a liquidity withdrawal scenario, would make it more difficult to fund the deficit. In South Africa, “we expect higher credit losses for unsecured loans (10% of total loans) as low economic growth and high household inflation restrain retail clients' repayment capacity in 2014”.

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