Yellen: not dovish enough?

FX

In her testimony to the Senate Banking Committee yesterday, Fed Chair Janet Yellen mostly reiterated what we already know from the Fed. In her prepared remarks, she confirmed that “if incoming data continue to support our expectation[s]” that the FOMC would continue to make “measured reductions” in the pace of its asset purchases, “with purchases concluding after the October meeting”. In response to a question from one of the Committee members, she added that while asset purchases were “not on a preset course” a “significant change” in the incoming data, enough to warrant a re-assessment of the FOMC’s outlook on the labour market and inflation, would be required before considering a deviation from the current plan. With regard to future rate hikes, in line with previous Fed statements, she said that “a high degree of monetary policy accommodation remains appropriate”, and that the “current target range for the federal funds rate likely will be appropriate for a considerable period after the asset purchase program ends”. Markets might have been a little unnerved by the comment, in her prepared testimony, that “if the labor market continues to improve more quickly than anticipated … then increases in the federal funds rate target would likely occur sooner and be more rapid than currently envisioned”, although this was immediately followed by the converse of this statement – “if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated”. Nevertheless, risky assets unwound gains made in anticipation of her testimony, and remained on the back foot overnight. She reiterated that “the recovery is not yet complete”, citing concerns over the weakness in the labour force participation rate and “other indications that significant slack remains in the labor markets … corroborated by the continued slow pace of growth in most measures of hourly compensation”. She appeared to downplay any concerns over rising inflation, citing that it still remains below the FOMC’s 2% objective, that core inflation is lower than the headline figure and that the FOMC’s projections for this year place both headline and core at between 1.5% and 1.75%. When asked what her main concern at the moment might be, reiterating comments from her prepared remarks, she mentioned the disappointing progress in the housing sector since last year’s increase in mortgage rates. However, she did add that weakness here was not seen as quantitatively large enough to undo the progress in overall economic activity that the FOMC was currently anticipating.

Today, Yellen will continue her testimony, this time appearing before the House Financial Services Committee. US industrial production, PPI and the Fed’s Beige Book will also be released today. Industrial production growth is expected to slow to 0.3% m/m in June (Bloomberg consensus) from 0.6% m/m in May. PPI inflation is seen easing to 1.9% y/y in June, from May’s 2.0% y/y.

China’s economy expanded by 7.5% y/y in Q2:14, accelerating from 7.4% in Q1:14, according to data released overnight. China's economy expanded 2% q/q from the previous quarter on a seasonally-adjusted basis – up from 1.4% q/q in Q1:14. The prints exceeded expectations (Bloomberg consensus: 7.4% y/y, 1.8% q/q), but as our Asia Economist, Jeremy Stevens, points out the newsflow from the economy over the past couple of months did suggest that the risks to the forecasts were to the upside. This might been that any reaction from commodities and commodity currencies might be tempered. The government's efforts to support the economy are taking effect, placing a floor under the loss in economic momentum. In particular, stronger fixed industrial output in June exemplifies the impact of Beijing's efforts. For now, the “rebound” remains policy dependent. Back in March, it seemed to be that the leadership was not actually fully committed to hitting its growth target. The government seemed to have placed employment at the centre of the discussion. With a goal of creating 10 million jobs in 2014 which was less than the 11.9 million jobs created in 2013, this suggested that policies would be relatively neutral. But, on June 6th, Li Keqiang held a meeting with the leaders of eight provinces where he stated that the government’s 7.5% economic growth target was legally binding since it had been ratified by the National People’s Congress. Jeremy notes that true to form, over the past three months or so, barely a day has gone by where some targeted support measure for the economy has not been announced or expanded. The State Council has directed agencies to accelerate spending on railways, and urban development, increased the tax threshold for SMEs. The PBoC has cut RRRs for all but the largest banks, encouraged lending for mortgages, embarked on a relending programme for agriculture, small businesses and low-income housing. The CBRC is broadening the scope of deposits it includes in the denominator of the loan-to-deposit ratios. Small individually, but as a group it’s clear that a definitive easing program is underway.

On the local data calendar we have the release of retail sales data today. 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. 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.

The rand weakened against the dollar yesterday, closing at USDZAR10.71, compared with Monday’s close of USDZAR10.68. Local currency depreciation occurred alongside a mixed performance from the dollar against the major crosses. The rand depreciated into a weaker 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 yen, while weakening against the pound. As already mentioned, 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 MXN (appreciated) and the THB (unchanged). The rand was the second-best performing currency in the commodity currencies category and took up the middle position in the EM currencies category (beating only the TRY, the HUF and the IDR). The rand traded between a low of USDZAR10.6342 and a high of USDZAR10.7287. 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, gold, Brent and platinum fell by 1.0%, 0.9% and 0.7% respectively. Copper meanwhile rose by 0.1%. The ALSI rose by 0.4% and the EM MSCI rose by 0.3%. The EMBI spread and the SA CDS 5yr spread both widened by 2 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, rose by 1.2%.

Non-residents were mild net buyers of local equities (ZAR119 million) and were net buyers of local bonds (ZAR235 million) on the day. Buying was seen in the 12+ (ZAR738 million), 1-3 (ZAR34 million) and 7-12 (ZAR2 million) year buckets. Selling was meanwhile seen in the 3-7 (-ZAR539 million) year segment. Bond yields fell on the day by between 6 bps (R208 and R214) and 8 bps (R203). The 3x6, 6x9 12x15 FRAs fell by 2 bps, 3 bps and 4 bps respectively.

In local labour news, as an update on the strike in the metals and engineering sector (which began on 1 July), Karl Cloete, Numsa’s deputy general secretary, said yesterday, "Seifsa has withdrawn its latest offer. This will obviously harden attitudes." Seifsa made an offer of a 10% wage increase in 2014, 9.5% in 2015, and 9% in 2016. However, over the weekend, Numsa rejected this offer with the rationale that it would accept a 10% increase in a one-year deal or 10% for each year in a three-year deal. Also, Neasa (National Employers' Association of SA) has offered an across the board wage escalation of 8% subject to a lower entry-level wage for new employees.

FI

Yesterday’s nominal government bond auction of the R2030, R2032 and R2044 saw a decent pick-up in demand. It was the inaugural issue of NT’s new R2044 bond, which outperformed its pricing expectation, clearing at a spread of 6.5 bps above the R214. The R2030 also outperformed, clearing at a yield of 8.74%, 3.00 bps stronger than the market, while the R2032 priced at 8.915%, roughly in line with the market. Bids increased to ZAR8.63bn from ZAR6.45bn at the prior auction, for an auction bid/cover ratio of 3.7x yesterday; this compares with a bid/cover of 2.3x at last week’s offering. The R2030 was the clear outperformer at yesterday’s auction, both in pricing and considering investor interest, with the bond receiving 48% of the auction’s total bids. The R2032 attracted 31% of the bids, and the R2044 received the remaining 21%. Investor interest in the R2030 and the new R2044 was aggressive, with a small proportion of total successful and fully allocated bids recorded in these bonds.

The rand depreciated sharply yesterday after the local bond market trading session had already closed. Prior to the sell-off in the currency, however, both the FI and currency markets strengthened significantly through the day. The appreciation in the currency was in line with moves stronger seen in most of the EM currencies we monitor for the purposes of this report. Similarly, the significant depreciation in the currency late yesterday (following Federal Reserve Chair Janet Yellen’s Semi-Annual Testimony to the US Congress) occurred broadly across the EM currencies. The negative movement in the currency could see SAGBs play catch-up this morning, with yields likely to trade north. And, while US Treasury yields also sold-off late yesterday afternoon (local time), USTs are trading at stronger levels this morning. The previous few days have seen SAGBs take direction from the rand, so the strengthening in USTs could be overlooked if the rand remains at current weaker levels.

The local FI market strengthened yesterday. Nominal SAGB yields fell by between 1.50 bps and 9.00 bps across the local yield curve yesterday. The yield on the R2030 and R213 fell by the largest increments, of 9.00 bps and 8.00 bps respectively to 8.69% and 8.70%. At the short-end, the yield on the R157 fell by the smallest increment, of 1.50 bps to 6.65% and the yields on the R203 and R207 fell by 7.50 bps and 7.00 bps respectively. The yield on the R186 fell by 7.00 bps to 8.24%. The longest-dated R2048 fell by 5.50 bps to a yield of 9.01%. USDZAR depreciated by 3c to 10.71 yesterday. US Treasury yields weakened in a flattening of the US Treasury curve. At the short-end, the yields on the 2yr and 5yr USTs rose by 1.60 bps and 1.65 bps respectively, to 0.48% and 1.69%. The yield on the 10yr note remained unchanged, ending the trading session at a yield of 2.55%. The exception was the yield on the 30yr note, which fell by less than 0.50 of a bp.

The front- and mid-segments of the yield curve flattened yesterday, while the long-end of the curve steepened marginally. At the front-end, the spread on the R186/R157 compressed by 5.50 bps to 159.50 bps; the spread on the R213/R186 at the belly compressed by 1.00 bp ending the day at a spread of 46.00 bps; and at the back-end, the spread on the R2048/R186 widened by 1.50 bps, to 76.50 bps. Total SAGB picked up in line with the nominal government bond auction, to ZAR23.98bn from ZAR16.92bn the day before. ZAR23.91bn of yesterday’s turnover was due to nominal SAGBs.

Non-residents were net buyers of nominal SAGBs yesterday, for a total of +ZAR235m. Foreigners purchased +ZAR738m in the 12+ year segment due to large inflows into the R2032 (+ZAR392m), R186 (+ZAR236m) and R2030 (+ZAR179m). -ZAR539m was sold in the 3-7 year segment stemming from the R204 (-ZAR391m) and the R207 (-ZAR157m).

EM FI markets that we monitor for the purposes of our reports strengthened overall yesterday. 5yr EM bond yields fell by 0.74 of a bp on average, and 10yr yields fell by 1.32 bps on average. SA’s FI market recorded a strong performance (third-best), with the 5yr yield declining by 5.20 bps, and the 10yr yield declining by 5.20 bps (and also outperformed relative to the EM average). Turkey’s FI market recorded the best performance overall, with the 5yr and 10yr yields declining by 6.00 bps each. India recorded the second-best performance with its 5yr and 10yr yields declining by 6.00 bps and 5.30 bps respectively. FI markets in Poland and Hungary performed poorly, recording the two worst performances in the EM space. Poland’s 5yr and 10yr yields rose by 6.20 bps and 6.30 bps respectively, and Hungary’s 5yr and 10yr yields rose by 6.00 bps and 4.00 bps respectively.

EM currencies depreciated significantly yesterday. While many of the EM currencies we monitor for the purposes of our reports (including the rand) strengthened in anticipation of Fed Chair Yellen’s Testimony yesterday, there was a widespread sell-off following the Testimony. The rand depreciated by 0.31%. Other EM currencies to depreciate overall yesterday, were the Indonesian rupiah (0.61%), Hungarian forint (0.50%), Polish zloty (0.35%), Turkish lira (0.34%), Brazilian real (0.31%) and Indian rupee (0.10%). Brazil’s central bank will conclude its monetary policy meeting today, and Bloomberg consensus expectations are for an unchanged rate of 11.00%.

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