MPC meeting: a tough call

FX

We expect that the SARB will take rates up by 25 bps at this week’s MPC meeting (policy announcement on Thursday, 17 July). This view is premised largely on concerns the Bank might have regarding their perceived credibility, especially with inflation above the target band and having reached 6.6% y/y in May. The Bank is acutely aware that its credibility and consequently, its ability to ensure that inflation expectations remain well anchored, which is its ultimate goal as an inflation targeting central bank, has been placed in a precarious position. With inflation having breached the target ceiling, and anticipated by the Bank to remain outside the band for an extended period, it will view the threat that expectations become adrift as particularly severe. Inflation expectations tend to be backward-looking, and consequently an extended period of inflation above 6% could provoke an unmooring of these expectations. These concerns are exacerbated further, and the SARB’s discomfort is increased, since expectations while anchored, are anchored at the upper end of the target band. As the SARB itself has put it in its most recent Monetary Policy Review, published in June, “inflation expectations are clustered at the top end of the target, reducing policymakers’ leeway to accommodate shocks”. In viewing any threat to inflation expectations the SARB, like in January, would not wait to see incontrovertible evidence of expectations becoming unmoored before it acts – it will act to any apparent and material threat to these expectations. However, we would stress that this is by no means a clear cut decision. The stagflation “dilemma” persists, and as we have pointed out previously, the natural inclination of a central bank in such a situation is to remain on hold. Consequently, the risk that the Bank remains on hold at the upcoming meeting is material.

Aside from the MPC meeting, the other notable event on the local data calendar is the release of retail sales data on Wednesday (16 May). Consensus views show retail sales growth falling to 0.7% y/y in May from 1.8% y/y in April. In contrast with April, y/y growth in retail sales will face notably unfavourable base effects in May, following the strong 1.5% m/m (seasonally adjusted) rise in retail sales in May 2013. SBGS economist Kim Silberman expects growth to ease to 1.3% y/y in May, down from 1.8%y/y in April. Inflation is expected to weigh on domestic demand in May; CPI accelerated to 6.6% y/y, led by goods price inflation, which rose to 7.5% y/y, up from 6.3% y/y in April. Total household credit growth eased to 4.3% y/y in May from 4.6% y/y in April, with slowing credit growth acting as a further dampener to consumer purchasing power. Currency market consequences of these numbers should be judged via what they signal regarding domestic household demand and what this means both for the current account and local interest rates. There is thus some ambiguity regarding what weakness in retail sales could mean for the rand, but we are inclined to think that the interest rate dimension would be of greater importance in any exchange rate response. Whereas arguably random events that are seen to temporarily knock exports – such as strikes, which are rand and thus potentially inflation negative – might not serve as a clear reason to tighten monetary policy, stubbornness in certain categories of imports that can be linked to consumer demand are another matter, posing what could be viewed as an endogenous risk to domestic inflation.

Fed Chair Janet Yellen will deliver her Semi-Annual Monetary Policy Report to Congress on Tuesday and Wednesday this week. Steve Barrow (our G10 Strategist) thinks that the key issue is probably whether Yellen is able to give more guidance on how (and perhaps when) the Fed might start to lift rates. The last set of Fed minutes clearly showed that the Fed has been thinking a bit more about it various policy instruments, giving a bit more clarity around the roles for the interest rate on excess reserves and the reverse repo rate. It is unlikely that Yellen will go into technical details about these instruments in her testimony this week, since it is mostly supposed to be an update to Congress on how the Fed thinks the economy is developing. But there might still be a bit more guidance about the Fed’s thinking on rates and that alone is good reason for the market to pay close attention.

Eurozone industrial production data for May will be released today. It comes after a string of pretty poor national data last week from the likes of Germany, Netherlands, France and Italy. Not surprisingly, the call for the May reading is a very weak -1.2% m/m (Bloomberg consensus) but Steve suspects that it will be weaker still. If the consensus forecast is correct, Steve points out that the annual rate will fall from 1.4% y/y in April to 0.5% y/y in May. Such a decline could start to place real question marks over the recovery in annual output that’s broadly been in place since last year. Indeed, there are already some question marks given the performance in recent months. Weak activity readings out of the Eurozone should keep the prospect of further ECB easing in play. An increasingly accommodative ECB could to some extent soften the blow of Fed policy normalisation to emerging market currencies. Monetary policy divergence among the major central banks also reduces the risk that the global recovery will be derailed, which is (trade-weighted) rand-positive.

ECB President Draghi’s testimony in front of the European Parliament’s Economic and Monetary Committee today could be of interest. This is because it’s just about the most exhaustive explanation he gives of the present situation and hence could give away a bit more detail than we’ve seen before now. Presumably much of the testimony will involve a deeper explanation of the easing steps the Bank took in June and how they might, or might not, be having a bearing on the economy and financial markets already.

The rand weakened further against the dollar Friday, closing at USDZAR10.71, compared with Thursday’s close of USDZAR10.70. Local currency depreciation occurred alongside a mixed to stronger performance from the dollar against the major crosses. The rand depreciated into a weak performance from all of the commodity currencies and most of the EM currencies we monitor for the purposes of this report. The dollar strengthened against the euro and the pound, while weakening against the yen. All of the commodity currencies we monitor depreciated on the day. Most of the EM currencies we monitor for the purposes of this report depreciated on the day, the exceptions were the INR, TRY and the THB (all of which appreciated). The rand ranked second-best in the commodity currencies category (beaten only by the AUD) and took up the middle to lower position in the EM currencies category (beating only the RUB, the IDR and the HUF). The rand traded between a low of USDZAR10.6827 and a high of USDZAR10.7400. Support from where the rand opened this morning sits at 10.7200, 10.6800, 10.6250, 10.5800 and 10.5200. Resistance levels sit at 10.7800, 10.8200, 10.9000, 10.9400 and 11.0000.

Turning to commodity prices, Brent, copper and platinum fell by 1.9%, 0.1% and 0.04% respectively. Gold meanwhile rose by 0.2%. The ALSI rose by 0.3%, while the EM MSCI fell by 0.4%. The EMBI spread and the SA CDS 5yr spread both widened by 1 bp. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 4.1%.

Non-residents were moderate net sellers of local equities (-ZAR404 million) but were mild net buyers of local bonds (ZAR29 million) on the day. Buying was seen in the 3-7 (ZAR98 million), 7-12 (ZAR94 million) and 1-3 (ZAR0.7 million) year buckets. Selling was meanwhile seen in the 12+ (-ZAR164 million) year segment. Bond yields nevertheless rose on the day by between 1 bp (R203) and 3 bps (R186 and R214). The 3-month Jibar rose by approximately 1 bp from 5.825% to 5.833%. The 12x15 FRA rose by 2 bps, while the 3x6 and 6x9 FRAs remained unchanged.

In local labour news, with regard to the strike in the metals and engineering sector, it was reported that Numsa reduced its wage demand to 10% from 12% on Sunday. Irvin Jim, Numsa general secretary, said, "[w]e are ready to end the current strike with a one-year agreement and a 10% wage increase … If employers want a three-year agreement, they must meet workers’ demand of double-digit increases." The Seifsa is offering a three-year package that would see workers getting 10% in 2014, 9.5% in 2015 and 9% in 2016 (the third year). A meeting is scheduled today between the union and Seifsa, and employers are expecting a briefing about Numsa’s position.

FI

The local FI market weakened overall as yields rose by between 1 bp and 3.00 bps across the local yield curve on Friday; this was on the back of a weaker and volatile currency, and in contrast to the moves (stronger) seen across US Treasury yields. SAGBs in the middle- to back-ends of the curve rose by the largest increments, while yields at the very short-end rose by the smallest increments. The yield on the R157 rose by 1.00 bp to 6.70% and the yields on the R203 and R204 rose by 1.50 bps each. The yield on the R186 rose by 3.00 bps to 8.34%; other bonds to also weaken by 3.00 bps were the R213, R209, R2037 and R214. The longest-dated R2048 rose by 2.50 bps to a yield of 9.09%. USDZAR depreciated on Friday, by 1c to 10.71. US Treasury yields strengthened in a bull flattening of the curve on Friday. At the short-end, the yields on the 2yr and 5yr USTs fell by 0.62 of a bp and 0.98 of a bp respectively, to 0.45% and 1.64%. At the longer-end, the yields on the 10yr and 30yr notes fell by the largest increments of 2.00 bps and 3.32 bps, to 2.52% and 3.34% respectively.

The front of the yield curve steepened on Friday, while the belly and the back-end of the curve flattened marginally. At the front-end, the spread on the R186/R157 widened by 2.00 bps to 164.50 bps; the spread on the R213/R186 at the belly compressed by 0.50 of a bp ending the day at a spread of 47.50 bps; and at the back-end, the spread on the R2048/R186 compressed by 0.50 of a bp, to 74.50 bps. Total SAGB turnover fell further, to ZAR9.97bn on Friday, from ZAR11.40bn on Thursday. ZAR7.98bn of Friday’s turnover was due to nominal SAGBs, with a relatively large proportion of the turnover (ZAR2.00bn) recorded in ILBs due to the government ILB auction on the day. Considering nominal turnover, 25% of the turnover was recorded in the R186, and 16% was in the R2048. A relatively high 14% of turnover was also seen in the R2048.

Non-residents were marginal buyers of nominal SAGBs on Friday, for a total of +ZAR29m. However, meaningful inflows and outflows were recorded across the curve on the day. Foreigners purchased ZAR114m in the R204 at the front-end, and +ZAR94m in the R2023 in the 7-12 year bucket. At the long-end, the only notable inflows were seen in the R186 (+ZAR118m) and the R2037 (+ZAR85m). Foreigners were net sellers on balance at the long-end, with net outflows recorded in the R2048 (-ZAR240m), R214 (-ZAR111m) and R209 (-ZAR92m).

Friday’s government ILB auction of the I2025, I2038 and I2050 saw a week-on-week improvement in total bids, to ZAR1.39bn from ZAR1.20bn at the previous week’s offering, resulting in a bid/cover ratio of 1.7x (prior week: 1.5x).The auction’s pricing levels across the three bonds was exactly in line with its respective prior day closing MTM yields. The I2025 cleared at 1.605%, the I2038 cleared at 1.82% and the I2050 cleared 1.985%. The I2038 and the I2050 were also the previous week, and both yields remained constant week-on-week. Market participation increased to 19 participants at the auction compared with a low 15 participants the prior week. The I2025 attracted the largest proportion of the bid volumes, with 40% of bids going to the bond, followed by the I2050, which received 35% of bids, while the I2038 received the remaining 25%.

EM FI and currency markets that we monitor for the purposes of our reports weakened overall on Friday. 5yr EM bond yields rose by 1.28 bps on average, and 10yr yields rose by 1.58 bps on average. SA’s FI market recorded a weak performance, with the 5yr yield rising by 1.80 bps, and the 10yr yield rising by 2.60 bps (also underperforming relative to the EM average). Hungary’s FI market recorded the worst performance in the 5yr space, with the yield rising by a relatively large 8.00 bps, followed by Russia’s 5yr yield, which rose by 4.68 bps. In the 10yr space, Indonesia’s 10yr yield rose by 6.60 bps, followed by Hungary’s 10yr note, which rose by 4.00 bps. Turkey’s FI market recorded the best performance in the 5yr and 10yr spaces, with both yields declining by 3.00 bps on the day. Mexico’s FI market recorded the third-best overall performance, with the respective 5yr and 10yr yields declining by 1.20 bps and 0.80 of a bp. Mexico’s central bank opted to leave the country’s overnight benchmark interest rate unchanged, at 3.00% on Friday at the conclusion of its monetary policy meeting.

EM currencies delivered a mixed performance on Friday. The rand depreciated by 0.06% on Friday, compared with larger moves weaker seen in a few of the other EM currencies we monitor. The Russian ruble led the moves weaker, recording a 0.70% depreciation on the day, followed by the Indonesian rupiah, which depreciated by a more marginal 0.12%. This followed a stellar week for the rupiah, which saw the currency appreciate by 2.40% in total over the past five trading days. In contrast, the Indian rupee appreciated by 0.44% on Friday; other currencies to appreciate on the day were the Turkish lira (0.44%) and the Thai bhat (0.16%).

The possibility of a default from the Argentinian sovereign and likelihood of a default in Portugal’s credit market, with a likely effect on the country’s second-largest bank, provides upside risk to the performance of EM financial markets over the next few weeks. However, this also hinges on DM sentiment, as, so far, markets appear to be judging the Argentinean situation as a lack of willingness to pay rather than an inability to do so. The situation is being complicated by the involvement of US courts.

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