Few surprises in the Budget but still it may drag down growth

• Fed Chair Janet Yellen continued her testimony on Capitol Hill yesterday, this time before the House Financial Services Committee. As was the case with her first day of testimony, she did not provide much in the way of new insights regarding the Fed’s thinking. She maintained the stance that the Fed could start hiking rates later this year, so long as the economy continues to strengthen.

• On the international data calendar, we have Eurozone money supply numbers and US CPI. Steve Barrow (our G10 FIC Strategist) thinks the monetary data could be a bit stronger than the consensus although he admits that, while it’s important data for the ECB, it still fails to elicit any real response from the market.

• US CPI data should show another large monthly drop, thanks to energy prices. The consensus is for a fall of -0.6% m/m but, for core prices, a 0.1% m/m increase is anticipated. If the consensus is correct, or it falls further in monthly terms, annual inflation will turn negative. A negative annual headline rate might make the national news but presumably won’t mean much when it comes to the market’s thinking about Fed policy.

• The February 2015 National Budget was tabled in parliament yesterday. Finance Minister Nene noted that the 2015 Budget was constrained by the need to consolidate public finance while being mindful of slower GDP growth and rising debt levels.

• We believe that increase in the marginal tax rate is negative for growth, while the fuel levy is likely to push inflation higher.

• A quiet day in bonds in expected, as markets digest the budget. However, with the 10yr UST still trading below 2.0%, external impetus is bullish on the day.

• The rand continues to benefit from increased global risk appetite. Our mid-point for the rand in Q1:15 remains at 11.50. Key support for the rand is at 11.3697 – its 100 day MA. Resistance is at 11.5739.

International developments

Fed Chair Janet Yellen continued her testimony on Capitol Hill yesterday, this time before the House Financial Services Committee. As was the case with her first day of testimony, she did not provide much in the way of new insights regarding the Fed’s thinking. She maintained the stance that the Fed could start raising rates later this year, so long as the economy continues to strengthen. Our base case is that the first rate hike will occur in September. The Fed could still drop the word “patient” at the March meeting and hike in September, even though the market might anticipate a hike in June. Steve Barrow (our G10 FIC Strategist) feels that the Fed might want the market to almost over-discount a rate hike, to ensure a benign response. It did this with the taper announcement (which was widely expected in September 2013 but delivered that December). A similar plan with the first rate hike would see a widely-expected rate hike in June delayed until September. Of course, Steve points out that all this presupposes that the Fed wants to game the market in this way and that nothing comes up to knock the Fed off course.

On the international data calendar, we have Eurozone money supply numbers and US CPI. Steve notes that Eurozone monetary data has turned into a much more positive release in recent months as signs finally emerge that all this ECB easing is having some impact. Annual M3 growth is expected to accelerate again in January, with a 3.7% annual rise and 3.4% on a three-month average basis. However, we have still not reached a point where annual private sector loan growth has turned positive – but we’re getting closer. In December, private sector loan growth was down -0.5% in annual terms and in today’s data for January the consensus looks for -0.3%. Steve thinks that all the monetary data could be a bit stronger than the consensus although he admits that, while it’s important data for the ECB, it still fails to elicit any real response from the market.

US CPI data should show another large monthly drop, thanks to energy prices. The consensus is for a fall of -0.6% m/m but, for core prices, a 0.1% m/m increase is anticipated. Not surprisingly, there’s a wide range of estimates for the headline data, while the core forecasts are grouped in a much smaller range. Steve thinks the odds favour an on-consensus 0.1% m/m rise in the core rate although the headline CPI might not fall quite as far as the market is expecting. If Steve’s view of the monthly headline inflation rate is correct annual inflation will stay out of the red. But, if the consensus is correct, or it falls further in monthly terms, annual inflation will turn negative. The consensus puts the annual rate at -0.1% after 0.8% last time but, crucially, the core rate is seen stable in annual terms at 1.6%. A negative annual headline rate might make the national news but presumably won’t mean much when it comes to the market’s thinking about Fed policy.

Domestic developments

The February 2015 National Budget was tabled in parliament yesterday. Finance Minister Nene noted that the 2015 Budget was constrained by the need to consolidate public finance while being mindful of slower GDP growth and rising debt levels. National Treasury decreased their real GDP growth forecast for 2015 and 2016, but kept the growth rate unchanged for 2017. NT now sees growth at 2.0% y/y in 2015 (vs. 2.5% y/y in MTBPS), 2.4% in 2016 (vs. 2.8% in the MTBPS) and 3% in 2017 (unchanged from the MTBPS). In our view the risk to the growth forecast lies in the nominal GDP growth. For the calendar year 2015 NT has increased the GDP deflator 6.1% y/y from 5.8% in the MTBPS. The higher nominal GDP growth rate of 8.2% for 2015 may overstate projections for revenue and possibly lead to higher expenditure.

The budget deficit target for 2014/15 is estimated at -3.9% of GDP, against indications from the 2014 MTBPS of a -4.1% deficit. This decrease in the deficit is largely a function of the rebasing of South Africa’s GDP in 2014. There is some fiscal slippage relative to indication from the MTBPS, with the deficit target now put at -3.9% for the 2015/16 fiscal year, as opposed to a target of -3.6% in the MTPBS. Going into 2016/17 and 2017/18, deficit targets remain unchanged.

The main tax proposals highlighted in the Budget were as follows:

• An increase in the marginal tax rate for tax payers paying more than R181,900. After adjusting for fiscal drag and medical credits, NT estimates that the revenue gain from changes the personal income tax rates will be zero. That said, individuals will still pay R9.44bn more in taxes due to the rise in the marginal tax rate than what would have otherwise been the case.

• Raising the general fuel levy by 80.5c/l; of this 30.5c/l will go to the general fuel levy and 50c/l will go towards the road accident fund. The rise in the fuel levy is set to increase taxes as a percentage of the pump price as of February this year from 27.6% for 93 octane petrol in Gauteng to 40.9%. The increase in the general fuel levy is set to increase revenue by R6.49bn.

• An electricity levy was proposed to manage electricity demand in the face of current constraints. The proposal is the increase the electricity levy from 3.5c/kWh to 5.5c/kWh. This 2c increase is temporary and is set to be replaced by a carbon tax in 2016.

We believe that increase in the marginal tax rate is negative for growth, and the fuel levy is likely to push inflation higher.

Markets

The rand strengthened further on Wednesday, closing at 11.45, compared to Tuesday’s close of 11.48. The rand’s appreciation occurred in line with dollar weakness against all of the majors; the dollar weakened against the pound (-0.5%), the euro (-0.2%) and the yen (-0.1%). The rand strengthened against most of the major crosses; the dollar (0.2%), the yen (0.1%) and the euro (0.1%), but weakened against the pound (-0.3%). The rand put in the worst performance amongst the commodity currencies we monitor, but the third-best performance amongst the EM currencies, only behind the RUB and HUF. The rand traded between a low of USDZAR11.4082 and a high of USDZAR11.5238 intraday.

Turnover was recorded at R27.8bn in nominals SAGBs and R530m in ILBs. 40% of turnover came from the R186, with decent contributions from the R2037 and R2048. Offshore investors were net sellers on the day of R1.9bn, selling almost across the curve: R158 (-R818m), R159 (-R509m), R2032 (-R424m) and R213 (-R151m). Buying was in the R207 (+R254m), R209 (+R147m) and R2030 (+R107m).

Bonds rallied on the day, following the slightly stronger USDZAR. The curve was 4.0 – 6.5 bps stronger, led by the R2044. The benchmark R186 was 5 bps stronger. FRAs ticked very marginally higher. However, UST Treasuries continued their recent rally, 10yr is trading at 1.96%.

Commodities were mixed on Wednesday. Gold and platinum were up on the day, rising by 0.4% and 0.6% respectively. Copper was down by 0.2% on Wednesday. Brent increased by 5.1% on the day to close at $61.63/bbl. Both the developed market MSCI and MSCI EM were up on Wednesday, by 0.1% and 0.5% respectively. The ALSI slipped by 0.3% on Wednesday. The EMBI narrowed by 2 bps on Wednesday while the SA’s 5yr CDS spread widened by 1 bp on the day. The CBOE VIX Index, a volatility-based proxy for global risk appetite/aversion, increased by 1.1% on Wednesday.

Latest SA publications

SA Macroeconomics: Economics Note: 2014 GDP 1.5% y/y, 1.3% q/q: Q4:14 outperforms post strikes by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (24 February 2015)

SA Fixed Income Trade Idea: Time to receive 8x11 FRA by Asher Lipson (24 February 2015)

Credit & Securitisation Flash Note: Curro Holdings Ltd by Steffen Kriel (23 February 2015)

SA FX Weekly: Budget 2015: time to deliver by Marc Ground and Shireen Darmalingam (23 February 2015)

SA Macroeconomics: Economics Note: 2015 Budget: commitment to consolidation: GDP, Budget, PSCE, PPI & Trade data to be released this week by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (23 February 2015)

Credit & Securitisation Weekly: Upcoming National Budget by Steffen Kriel and Varushka Singh (20 February 2015)

SA Macroeconomics: Economics Note: Retail sales grew 3.4% y/y, in December and 2.4% in 2014: Festive season saw food, pharma, clothing & furniture outperform by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (18 February 2015)

SA Macroeconomics: Economics Note: CPI falls to 4.4% y/y, core rises: Food surprises to the downside by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (18 February 2015)

SA Fixed Income ALBI note: ALBI modified duration moves longer in March by Asher Lipson (17 February 2015)

SA FX Weekly: Risk aversion alive and kicking by Marc Ground and Shireen Darmalingam (16 February 2015)

SA Macroeconomics: Weekly Data Preview: Jan CPI expected to fall to 4.6%: Dec retail sales may surprise to the upside by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (16 February 2015)

Credit & Securitisation Weekly: Eskom at top of government’s agenda by Steffen Kriel and Varushka Singh (13 February 2015)

SA Macroeconomics: Economics Note: December manufacturing up 1.1%y/y, driven by food: Manufacturing grows 0.5 in 2014 by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (10 February 2015)

SA Macroeconomics: Economics Note: The lower oil price: Part 2: Impact on the current account deficit by Kim Silberman, Thanda Sithole and Kuvasha Naidoo (9 February 2015)