ECB: to ease or not to ease?

FX

Note: Today is a US public holiday (Labor Day).

In terms of international news, UK data will be the main focus today. However, the main market-moving events will come later in the week, in the shape of BoE/ECB meetings, and US payroll data. For today’s UK data, Steve Barrow – SBR’s G10 FIC strategist – thinks that the manufacturing PMI is likely to be the most interesting. We have seen some surveys out of the euro zone hit hard recently, in part owing to strains emanating from Russia. We will find out today whether similar issues are weighing on manufacturing sentiment in the UK. The consensus call is for the PMI to slip to 55 from 55.4. This would mark the second consecutive slide, and might raise some concern as the PMI has been in the 56-58 range for much of the last year. Steve is sceptical that the PMI will fall in the way the market expects, and hence sees the data release supporting sterling, although he thinks that the impact is likely to be fairly marginal.

The key issues this week will clearly be whether the ECB eases policy on Thursday, and whether US payroll data on Friday continues to show improvement in the labour market. There are some other issues around as well, such as whether there could be more dissent at the BoE on Thursday (in a hawkish direction), and whether the RBA and/or BoC could change their tone in their monetary policy meetings this week.

The possibility of ECB easing could keep the euro weak, but Steve thinks that it is perhaps more likely that it will just keep volatility down. Steve has argued for months that the ECB should – and will – conduct QE, but says he is simultaneously aware that the ECB’s next big thing, targeted long-term repos (TLTROs), are due to be launched this month. He believes that the ECB should want to hold back any QE for fear of undermining the TLTRO program. However, Draghi and other ECB members have dropped some hints of policy change, the most notable being the fall in longer-term inflation expectations, which the ECB has always referenced as a key to monetary policy. The ECB could cut the key refi rate, but this is only 15 bps, and any cut will thus have to be pretty small. It might pull something else out of the bag, such as more concrete details of its plans to buy ABS securities. In the end, Steve suspects that the ECB will deliver something to suggest policy has eased, but doesn’t think it will be full-scale government-bond-based QE just yet and, if that’s the case, the euro might be able to make a (temporary) comeback.

With regard to payrolls this Friday, the consensus forecast sits just above the 200k mark once again. Payroll growth has been pretty consistent around this sort of level for some time now. Steve sees risks to the upside on the basis that some indicators, like consumer confidence, are showing good jobs-related readings, but he doubts it will be a game-changer when it comes to the imminence of policy changes from the Fed.

Turning to local data releases, preliminary external trade numbers for July, published by SARS on Friday, showed the trade deficit widening out to -ZAR6.9 billion from an adversely revised -ZAR0.5 billion in June (prior estimate: -ZAR0.2 billion). The result sat materially wide of the consensus prediction of -ZAR4.0 billion. A portion of the deterioration was seasonal, explained by a fairly reliable m/m push in imports between June and July. Total imports rose to ZAR92.3 billion from ZAR80.4 billion in June, while exports climbed more modestly to ZAR85.4 billion from ZAR80.0 billion. The cumulative trade balance for the first seven months of 2014 sits at -ZAR55.5 billion, 35.0% wide of the score for the same period a year ago of -ZAR41.1 billion. The trade balance for July 2014 was 19.0% wide of the -ZAR5.8 billion in July last year, and thereby represents a bad start to Q3:14 in terms of current account deficit to GDP ratio guidance, even after nominal GDP growth over the intervening period is taken into account. Note also that the current account deficit hit its worst point in the cycle so far in Q3:13 at -6.4% of GDP. That said, with only one month’s worth of data available for the quarter so far, it is too early to draw firm conclusions; the lumpy and erratic nature of the trade numbers argues for some caution here. The main drivers of the m/m push in imports were increases in purchases of transport equipment and automotive components (up a combined ZAR2.7 billion m/m), machinery (ZAR2.5 billion) and mineral products (mainly oil, ZAR2.3 billion). Exports were supported mainly by increases in mineral products (up ZAR4.0 billion m/m). In the context of PGM industry strikes lasting till June, it is worth noting that precious materials exports rose by a modest ZAR0.9 billion, consistent with our view that normalisation of production and export levels from the industry will be gradual. On a more encouraging note, our smoothed measure of import growth (the y/y change in the 12mma) slid to 12.6% in July from 15.1% in June, extending a steady deceleration in place since April. The same measure of export growth dipped to 11.1% in July from 13.3% in June, dragged down most conspicuously by a -4.6% contraction in precious materials exports, once again a function of PGM industry strikes. SA’s comparatively wide current account deficit remains the Achilles’ heel of the currency market, especially into external financing challenges posed by the prospect of Fed tightening next year, and more dissent on the FOMC and hawkish drift in Fed rhetoric to be expected in the lead-up to that point. Worse than anticipated trade numbers are rand negative – signs of persistent pressure on the current account could preserve doubts among market participants about whether or not the rand has cheapened enough, notwithstanding pronounced nominal and real depreciation since late 2012.

National Treasury published its Statement of Revenue and Expenditure on Friday. The Budget balance came in at -ZAR69.7 billion, wide of consensus expectations pitched at -ZAR62.0 billion. The release showed revenues falling short as a share of budgeted annual estimates compared with last year, and by a more substantial margin compared with a simultaneous undershoot on the expenditure side of the accounts. YTD, 27.6% of annual budgeted revenues have been collected. The same time year ago, 28.2% of annual actual revenues had come in. With respect to spending, the numbers stand at 32.4% versus 32.5%, respectively. The breakdown of revenues shows customs duties, company tax, VAT, the general fuel levy receipts are behind. Personal income tax collections are meanwhile slightly ahead and dividend tax receipts materially ahead. Finance Minister Nhlanhla Nene indicated last week that government’s forecast for GDP growth this year was being adjusted to 1.8% from 2.7%, and that this placed government’s deficit targets at risk. He attributed the growth undershoot to challenges arising from strikes and supply side constraints, especially in the energy sector. According to Moneyweb, he noted that, while not wanting to strain economic growth, tax increases were not out of the question. “It’s something we should avoid at all costs but at the same time I don’t think it’s something we should rule out should there be a need and should it be warranted and justified,” he said. “It’s something that should be carefully considered.” Government finds itself caught between pressure to contain fiscal slippage, owing to creditworthiness and thus debt rating concerns, and a desire to support economic growth with a counter-cyclical fiscal stance. Its next Medium Term Budget Policy Statement will be tabled in October, but tax regime changes typically only occur in the main budget in February each year. Government’s debt to GDP ratio has been climbing rapidly since the US sub-prime crisis of 2008 and the subsequent slump in local economic growth performance; the MTEF shows this ratio heading still higher over the next three fiscal years. Government is likely to stay on the back-foot with the major rating agencies until it is able to credibly show it can turn this ratio around, a task that will prove difficult as long as growth continues to underperform – a scenario that we expect will continue into 2015.

Local manufacturing PMI and Naamsa vehicle sales numbers for August will be published today. Consensus (Bloomberg) pins the PMI still below the expansion/contraction threshold of 50.0 at 47.8, but above the July reading of 45.9. The PMI has been sub-50 since April this year. The decline in the PMI to 45.9 in July from 46.6 in June suggests that manufacturing output, will contract even further in Q3, SBGS economist Kim Silberman notes. The resolution of the PGM and NUMSA strikes, the resumption of motor vehicle production plus production of the new C class at Mercedes Benz, alongside some global recovery - albeit still uneven - will be supportive of manufacturing in 2H:14. This could explain the moderate lift in the index anticipated in the consensus forecast for August. However, the PMI's leading indicator (new orders minus inventories) in July pointed to a sharp fall in the PMI over the next few months, implying that the recovery in manufacturing may only gain traction in Q4:14. The consensus view regarding Naamsa vehicle sales is for a slight easing in the y/y pace of contraction to -1.2% in August from -1.5% in July. The contraction troughed at -10.5% in April. Growth of vehicle sales has now been in negative territory consistently since January this year, hit by general weakening of consumer demand, monetary policy tightening, some re-pricing of vehicle asset finance and rising vehicle prices. The bias towards a mild improvement in the y/y rate of change in the consensus forecast is consistent with the directional impact of base effects; in August last year, vehicle sales shrank by what appears to be an unseasonal- 4.2%. Signals of persistent weakness in activity indicators are rand negative in particular via their perceived consequences for monetary policy – that is, via the extent to which they increase the reluctance on the part of the SARB to hike the repo rate further.

SARB gold and foreign exchange reserves numbers for August will be published on Friday. We do not expect a material adjustment over July readings – that is, beyond valuation effects and a mild routine drawdown by government on its cash balances held with the SARB - in the foreign deposits received line - to meets its monthly foreign exchange commitments (foreign debt servicing obligations and operational costs of Foreign Affairs). Government drawdowns should impact only the gross reserves number, and should have no effect on net reserves. Consensus pins the gross reserves number slipping moderately to USD49.7 billion in August from USD49.9 billion in July, and net reserves dipping to USD44.1 billion from USD44.3 billion, likely based on combined impacts of a lower USD gold price on the value of gold holdings and of dollar strength on the value of non-USD foreign currency holdings between month ends. Our estimate for net reserves is in line with consensus, but we think that the risk to the forecast for gross reserves lies to the lower side of the median view, owing to government drawdowns mentioned above. The SARB has neither bought nor sold a material amount of reserves since the start of 2012. Reserves are not plentiful enough to offer a credible arsenal against any sustained selling pressure in the currency market, and the SARB in any case prefers to run with a flexible exchange rate – one that acts as an economic “shock absorber” into any balance of payments strains the country might from time to time face. While the Governor has hinted that higher levels of reserves might be a desirable luxury that could be used under more extreme circumstances, it is clear there is currently little appetite for the sterilisation costs attached to foreign exchange purchases, which are for the account of government, owing to already severe pressure on government finances.

The rand weakened moderately against the US dollar on Friday, closing at USDZAR10.67, compared with Thursday’s close of USDZAR10.65, on the back of local trade figures surprising to the downside (widening from -ZAR0.2bn in June to -ZAR6.9bn in July). The rand depreciated into a mixed to stronger performance from the dollar against the major crosses, weakness among commodity currencies and a mixed performance among EM currencies. The dollar strengthened against the euro and the yen, while weakening slightly against the pound, speaking to a story of global monetary policy divergence. The rand depreciated against the dollar and the pound, while strengthening against the euro and the yen. Four of the EM currencies we monitor (the ZAR, the TRY, the HUF and the RUB) depreciated on the day; three (the MXN, the IDR and the BRL) appreciated, while the remaining two (the THB and the INR) remained unchanged. The rand was the worst-performing commodity currency and took up the middle position in the EM commodity currencies category on the day. The rand traded between a low of USDZAR10.5904 and a high of USDZAR10.6735. Support from where the rand opened this morning sits at 10.6600, 10.6000, 10.5250 and 10.4600. Resistance levels sit at 10.6850, 10.7600, 10.7910 and 10.8350.

Turning to commodity prices, Brent and copper both rose by 0.7%. Gold and platinum meanwhile fell by 0.2% and 0.1%, respectively. The ALSI dipped by 0.4%, while the EM MSCI rose by 0.1% on the day. The EMBI spread widened by 1 bp, while SA’s 5yr CDS spread compressed by 3 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, edged down by 0.6%.

Non-residents were fairly aggressive net buyers of local equities (ZAR1 165 million), but were mild net buyers of local bonds (ZAR354 million). Buying of bonds was seen in the longer-dated 12+ (ZAR724 million) and 7-12 (ZAR581 million) year buckets. Selling was meanwhile seen in the shorter dated 1-3 (-ZAR616 million) and 3-7 (-ZAR335 million) year segments. Bond yields fell by between 5 bps (R203, R208 and R186) and 6 bps (R214). The 3x6 and the 6x9 FRAs fell by 4 bps, and the 12x15 FRA fell by 5 bps, into improving expectations regarding local monetary policy prospects.

FI

Today is a US public holiday, so we expect a particularly quiet Spring Day afternoon. Last week saw bonds rally by over 20 bps, apart from the R157 weakening prior to its split in two weeks’ time. Friday’s weaker than expected trade and fiscal balance should give the market something to think about this week, but there is little market moving data to digest this week. Friday’s weaker currency could put some pressure on bonds this morning. However US nonfarm payrolls at the end of this week is likely to dictate trade later in the week.

A surprisingly high ZAR28.2bn in nominal turnover on Friday, with an additional ZAR6.9bn trading in ILBs, and a stronger curve on the day. Almost ZAR10bn traded in the R186, accounting for 33% of turnover, while ZAR4.5bn traded in the R157, contributing 16% of the turnover. The R157 is likely to see increased trade prior to the 15 September forced split of the bond. ILB turnover was boosted by over a ZAR1bn trading in each of the I2025, R202 and I2038, of which the I2025 and I2038 were in the auction.

Friday’s ILB auction of the R212, I2025, I2038 saw strong demand. Total bids improved from the previous week, with all three bonds clearing stronger than their MTM closing yields, as well as stronger than the previous week’s auction clearing levels. Auction bids increased to ZAR1.95bn from the previous week’s ZAR1.86bn, recording an auction bid/cover ratio of 2.4x on Friday. Market participation improved to 27 participants from the 24 participants the previous week. The I2038 attracted the majority of investor interest, with 45% of the auction bids going to the bond, while the R212 received 38% of the bids, and the I2025, the remaining 17%. The I2038 was the outperformer of the auction, pricing at 1.85%, 2.50 bps below it’s closing MTM yield. The I2025 cleared at 1.65%, 2.00 bps more competitively, and the R212 priced at 1.56%, 1.00 bp more competitively.

Offshore investors were recorded as net buyers of ZAR353m, buying the 7-12yr and 12+yr buckets, but selling the 1-3yr (R157) and 3-7yr buckets. ZAR612m of R157 were sold, with over ZAR1.5bn sold during the week, suggesting some reduction in positions in the bond prior to its upcoming split, as well as it dropping out of the GBI indices on Friday. Large selling was also seen in the R186 (-ZAR628m), R213 (-ZAR260m) and R203 (280m). Buying was focussed on the R209 (ZAR811m), R2023 (ZAR581m), R2048 (ZAR571m), R214 (ZAR403m) and R208 (ZAR124m). Over the course of the week, offshore investors were net buyers of ZAR4.6bn, following five consecutive weeks of selling.

The entire curve rallied by 5.0 – 7.5 bps, apart from the R157 which strengthened by a comparatively lower 2 bps. Moves were led by the R2030; -7.5 bps stronger, with the benchmark R186 moving -5 bps stronger. FRAs followed the stronger bonds, ignoring the weaker currency. The 1x4, covering this month’s MPC meeting is now only trading 4.2 bps above 3m Jibar. 3m Jibar has however done some of the adjustment in the market, moving 15 bps higher since July’s hike. 4yr breakeven (R203/R211) is now trading below 6.0%, while 10yr (R2023/R197) is trading slightly above at 6.035%.

EM FI rallied on Friday, with 5 and 10yr local currency sovereign bonds moving an average of 0.55 bps and 1.83 bps lower. Russia was the only country we cover that saw its 5yr bonds weaken on Friday, while South Africa had the besting performing 5yr bonds, rallying by 6.00 bps. Russia also had the weakest 10yr bonds (+8.3 bps), with marginal weakness also seen in Poland. The rally in 10y bonds was led by Indonesia (-9.50 bps stronger), Turkey (-6.00 bps stronger), Brazil (-5.50 bps stronger) and South Africa (-4.90 bps stronger).