Fed: QE likely to end by October

FX

The minutes of the 17 to 18 June FOMC meeting were published yesterday. There was speculation that the minutes could prove somewhat more hawkish than the interpretation given by Fed Chair Yellen in the post-meeting press conference. However, this proved not to be the case. Of interest was the Committee’s continued discussion of monetary policy normalisation, although it was once again stressed that this “was undertaken as part of prudent planning and did not imply that normalisation would necessarily begin sometime soon”. The discussion focused on the use of the fixed-rate overnight reverse repurchase agreement (ON RRP) and the rate of interest on excess reserves (IOER) during the normalisation process. It was “generally agreed” that an ON RRP facility with a rate set below that of the IOER could “help to firm the floor under money market interest rates”. The appropriate spread between the IOER and ON RRP rates was discussed, with it being generally agreed that a fairly wide spread (of perhaps around 20 bps) would provide the necessary support and degree of control in the money market. A “few participants” mentioned that aside from the IOER and ON RRP, the Committee should also be prepared to make use of its other tools, such as term deposits and term reverse repurchase agreements. Most agreed that “the federal funds rate should continue to play a role in the Committee’s operating framework and communications”, with the preference for maintaining the current indication of a target range. There was some discussion around “more robust” options for calculating the effective fed funds rate.

As part of the Committee’s discussion on policy normalisation, the timing of changes to the current policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency and mortgage-backed debt was also addressed. “Many participants” favoured ending reinvestments “at or after the time of liftoff” – that is, at or after the first rate hike. “Most of these participants” preferred to end reinvestments “after liftoff”. All agreed that it would be best to follow “a graduated approach to winding down reinvestments or to manage reinvestments in a manner that would smooth the decline in the balance sheet”. It was noted that the Committee’s plans for policy normalisation should be developed and communicated to the public “later this year” before the first steps in the plan become appropriate.

The Committee debated the current winding down of asset purchases, reiterating that while the program “is not on a preset course”, should the economy evolve as anticipated “the program would likely be completed later this year”. There was a discussion around whether the final reduction would be a single USD15 billion or a USD10 billion reduction, followed by a USD5 billion reduction. Most participants felt that this was a “technical issue with no substantive macroeconomic consequences”. Nevertheless, it was generally agreed that “it would be appropriate to complete asset purchases with a $15 billion reduction … to avoid having the small, remaining level of purchases receive undue focus”. With current purchases at USD35 billion, this implies that the decision to reduce asset purchases by a final USD15 billion can be expected at the 16 to 17 September meeting – asset purchases would then cease in October. The September meeting might also offer an opportune time to communicate the Committee’s plans for policy normalisation, given that it will be accompanied by a post-meeting press conference. As such, as we approach this meeting, risky assets could be in for a bumpy ride, although we don’t think that the reaction will be as dramatic as last year’s taper tantrums.

China’s trade data for June, release overnight, was somewhat disappointing. Although export growth edge up to 7.2% y/y from 7.0% y/y in May, this was weaker than the market had anticipated, with Bloomberg consensus at 10.4% y/y. Capital Economics points out that the headline export figure is disappointing since a weak base for comparison — exports dropped 6.0% m/m in seasonally adjusted terms last June — should have pushed up y/y growth. By their calculations exports appear to have fallen 2.6% m/m in seasonally adjusted terms in June. Import growth picked up more sharply, from -1.6% y/y in May to +5.5% (Bloomberg consensus: 6.0% y/y). However, Capital Economics notes favourable base effects as mostly responsible for the strength, with imports calculated as largely flat in m/m seasonally adjusted terms. With the numbers not particularly inspiring, we don’t foresee them lending any significant impetus to commodities and commodity currencies today.

Mining and manufacturing production data for May will be published today. Consensus (Bloomberg) forecasts the contraction in mining output to resume; -4.9% y/y from +0.2% y/y in April. This is reflective of the y/y change coming off a very strong base; in May 2013, mining output expanded by 6.1% m/m on a seasonally adjusted basis. Pessimism regarding the outlook for mining output numbers is also likely owing to anticipated impacts of the five-month long PGM industry strike. The currency market consequences of mining output results should be interpreted mainly via what they signal regarding the current account balance, and also via their economic growth and interest rate consequences. On a net basis, weak mining output numbers should be read as rand negative.

Y/Y growth of manufacturing will be worked off a low base in May, suggesting a possible marked acceleration against the y/y reading of -1.5% for April. In April this year, base effects were extremely unfavourable as there was a 7.5% m/m, seasonally adjusted, increase recorded in April 2013. Consensus pins the outcome at -1.6% y/y. Market participants will be looking to measures of local manufacturing sector performance for indications as to what extent local industry has gained any competitive edge from the material and sustained cheapening of the currency over the past 18 months.

The rand strengthened slightly against the dollar yesterday, closing at USDZAR10.67, compared with Tuesday’s close of USDZAR10.68, on the back of the release of the relatively benign FOMC minutes. Local currency appreciation occurred alongside a mixed to weaker performance from the dollar against the major crosses. The rand appreciated into a strong performance from all of the commodity currencies and almost all of the EM currencies we monitor for the purposes of this report. The dollar weakened against the euro and the pound, while strengthening against the yen. All of the commodity currencies we monitor appreciated on the day. All but one of the EM currencies we monitor for the purposes of this report appreciated on the day, the exception was the HUF which depreciated slightly. The rand was the worst-performing commodity currency and the fourth-best-performing EM currency (beaten only by the RUB, the THB and the TRY). The rand traded between a low of USDZAR10.6538 and a high of USDZAR10.7190. Support from where the rand opened this morning sits at 10.6800, 10.6250, 10.5800, 10.5200 and 10.4800. Resistance levels sit at 10.7200, 10.7800, 10.8200, 10.9000, 10.9400 and 11.0000.

Turning to commodity prices, gold and platinum rose by 0.7% and 0.5% respectively. Brent and copper fell by 0.6% and 0.1%, respectively. The ALSI fell by 0.4% and the EM MSCI fell by 0.4%. The EMBI spread compressed by 2 bps the SA CDS 5yr spread compressed by 0.5 of bp. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 2.8%.

Non-residents were aggressive net buyers of local equities (ZAR1 271 million) but were meaningful net sellers of local bonds (-ZAR835 million) on the day. Selling was seen in the 7-12 (-ZAR683 million), 1-3 (-ZAR165 million) and 12+ (-ZAR143 million) year buckets. Buying was meanwhile seen in the 3-7 (ZAR157 million) year segment. Bond yields fell on the day by between 3 bps (R214) and 5bps (R203). The 3x6 and 6x9 FRAs both fell by 2 bps, and 12x15 FRA fell by 1 bp.

In local labour news, with regard to the strike in the metals and engineering sector, it has been reported that Numsa is mulling over the new offer from employers. It is understood that the current offer does not to exceed a previous offer of a 10% wage increase made by Seifsa last Friday. However, an increase in wages might not be the only sticking point between the parties, with the discussions covering over 35 separate items with regard to worker demands. Mokgadi Pela (Labour Minister Mildred Oliphant’s spokesman) indicated yesterday that in meetings with both the union and employers, both parties showed “encouraging commitment and maturity in finding a settlement”.

FI

The bond market is expected to take some direction from the currency and local production data out today, after two days of stronger moves. May mining production is due at 11:30, with consensus printing at -4.9% y/y, from a prior +0.2, while manufacturing production data is due at 13:00. Consensus puts the May print at -1.6% y/y, from a prior month’s -1.5%. We may start seeing some signs of the platinum strike in both sets of data, which would be negative for May trade figures and thus potentially negative for the Q2 current account. We have opened slightly stronger this morning.

Turnover remained low in the market on Wednesday, with ZAR13.85bn traded in nominal SAGBs and ZAR658m in inflation-linked bonds. A quarter of turnover was due to the R186, while the R203 and R204 saw unusually high turnover numbers with ZAR2.61bn and ZAR1.83bn traded respectively. The entire curve strengthened for a second day, though yesterday front-end rates led the moves. The R203 moved 5.5 bps lower, with the R204, R207 and R2023 all moving 4 bps lower. The benchmark R186 moved 3.5 bps lower, resulting in the front-end of the curve flattening slightly, with marginal steepening in the belly and back-end of the curve. Non-residents were net sellers of nominal SAGBs yesterday, for a total of -ZAR835m. Net outflows occurred across the curve; foreigner’s sold -ZAR683m in the R2023 in the 7-12 year category, and -ZAR165m in the R157 in the 1-3 year category. Foreigners sold -ZAR143m in the 12+ year segment, due to notable net selling in the R209 (-ZAR151m), R186 (-ZAR118m) and R214 (-ZAR97m), which was marginally offset by buying in the R2032 (+ZAR148m) within this category. Foreigners purchased +ZAR157m in the 3-7 year segment, due to net buying in the R204 (+ZAR372m), which was offset by selling of -ZAR174m in the R207.

Further information has come out on the BRICs bank, with each nation reported to have seven years to pay $2bn into the development bank. The establishment of such a bank would be viewed as positive for local assets.

US Treasury yields continued to strengthen yesterday in a bull curve steepening of the curve. The exception was the yield on the 30yr UST, which rose by a marginal 0.17 of a bp to 3.37%. The yield on the 2yr UST fell by the largest increment, of 2.79 bps to 0.48% and the yield on the 5yr note fell by 2.14 bps to 1.67%. The 10yr note strengthened by the smallest increment, of 0.54 of a bp to a yield of 2.55%.

EM FI and currency markets that we monitor for the purposes of our reports weakened overall yesterday. 5yr EM bond yields rose by 1.44 bps on average, and 10yr yields rose by 0.39 of a bp on average. SA’s FI market recorded the second-best performance in both the 5yr and 10yr spaces, and outperformed relative to the EM average; the 5yr yield fell by 4.20 bps and the 10yr yield fell by 3.90 bps. Hungary’s FI market recorded the best performance in the 5yr and 10yr spaces, with the 5yr yield declining by 5.00 bps and the 10yr yield declining by 4.00 bps. Turkey’s FI market recorded the worst performance, with the 5yr yield rising by a relatively large 15.00 bps and the 10yr yield rising by 12.00 bps. Poland’s market recorded the second-worst performance, with the 5yr and 10yr yields rising by 4.40 bps and 3.90 bps respectively, followed by Russia, with its respective 5yr and 10yr yields rising by 2.71 bps and 2.04 bps.

EM currencies appreciated on balance yesterday. The rand appreciated by a marginal 0.13%, compared with larger moves (stronger) seen in many of the other EM currencies we monitor. The Russian ruble led the moves stronger, recording a 0.81% appreciation on the day, followed by the Thai bhat, which appreciated by 0.62%. We noted yesterday, that the Indonesian rupiah had appreciated by 0.74% on Tuesday, following a significant appreciation of 1.35% in the rupiah on Monday in the run-up to the country’s presidential election. The Indonesian rupiah did not trade yesterday. Other EM currencies that appreciated meaningfully on the day were the Turkish lira (0.45%), the Polish zloty (0.27%) and the Mexican peso (0.11%). Indonesia will also conclude its central bank meeting today; Bloomberg market consensus forecasts are calling for an unchanged reference rate; it is currently 7.50%.

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