Risk-off persists ahead of FOMC

FX

There have been some interesting things going on in the dollar, Steve Barrow notes. The general word on the street seems to be that the dollar has been roaring ahead just recently. But, in fact, its strength has only really been against the other major currencies, like the euro, pound and yen; its advance against emerging market currencies has been much more pedestrian. What accounts for this difference and what does it suggest for the future? We’d argue that it partly reflects the fact that the global currency story right now is more one of weakness in other major currencies than dollar strength. Sure, there’s been talk of more hawkish Fed language next week that’s supported the dollar. But that might not happen. Instead, the more concrete changes recently have been in things like ECB policy (which has eased) and the Scottish referendum (where the polls have closed). This might explain why there’s been a bit of a dichotomy in the dollar’s performance in recent months. But what about the future? It seems to us that the key is whether the dollar’s story becomes more positive, or whether we’re just left with negative stories for the other major currencies. If it is the former, the dollar might start to rally hard against the EM currencies as well. If it is the latter the dollar may remain stickier against the EM currencies. The key to this may well be the Fed’s position. A notably hawkish change in the Fed’s statement next Wednesday could make EM currencies give back all their recent strength against the other major currencies (such as the euro, yen and pound). But we’re not sold on the idea that the Fed will do this. In fact, we still lean more to the view that the Fed will conduct the transition to tougher language and higher rates in a way that does not cause significant damage to global markets. We’ve no doubt that this is going to be a bit of a minefield for the Fed, and one wrong step could clearly cost EM currencies dearly. There might be the odd miss-steps, but we’re not expecting a repeat of the problems that global markets had last year as the Fed talked the taper talk in May before it walked the taper walk in December. If we’re right about this we should continue to see currencies such as the euro and yen underperform many of the emerging market currencies. And, while the dollar may continue to appreciate in broad terms, its rise may be most notable against developed market currencies, not developing ones. (See Steven Barrow’s G10 Daily: Major woes published this morning).

On the international front today, the only noteworthy release is perhaps US retails sales. The headline figure is seen rising by 0.6% m/m in August according to the Bloomberg consensus, and by 0.3% m/m once auto sales are excluded. In general terms, Steve Barrow (our G10 FIC Strategist) thinks it is fair to say that car sales have been doing pretty well in the US, even if there are some question marks around the creditworthiness of those receiving auto financing. The upshot is that total retail sales have not been too bad, but core sales – ex autos – have generally been poor. Today’s data should be another case in point. Not only is the headline figure seen well above the core (0.6% against 0.3%), but the skew on the core forecasts clearly lies to the low side. It is Steve’s view as well that core retail sales will fall short of the consensus and, if that’s correct, it may just ease some of the pressure on Treasuries and on the yen. Retail sales figures will be viewed via what they signal regarding the health of the US consumer and specifically what this implies regarding employment and wage growth. The Fed is keen to ensure that the stimulus it has applied, and continues to apply, results in diminishing slack in the labour market which in turn should put upward pressure on wages, and contribute to improving conditions for the average American. However, it’s the FOMC meeting next week, with the market not sure whether the Fed is going to make some significant changes to the language and hence pre-FOMC market movement might be a bit restricted. Nerves around next week’s meeting appear to have been the principal driver of risk-off sentiment of the past few days. Coupled with SA’s disappointing current account reading, this has left the rand particularly under pressure.

Money supply and lending data for China was published overnight. The numbers show that overall credit growth continued to slow. Growth in outstanding bank loans edged slightly lower to 13.3% y/y in August from 13.4% y/y in July. Growth in overall outstanding credit fell to 15.1% y/y (from 15.9% y/y) - the slowest pace of growth seen since 2005. Nevertheless, net new loans rebounded to RMB702.5 billion in August, from the abysmal RMB385.2 billion seen in July. Capital Economics feels this suggests that concerns over weak credit demand, after July’s weak numbers, were overdone. Capital Economics views the weaker credit growth data as more to do with the authorities’ crackdown on off-balance sheet lending, rather than to do with faltering demand for credit. If this is the market’s read on the data, we could see a lift in commodities and commodity currencies today, although this might not be enough to offset anxieties ahead of next week’s FOMC meeting, which appear to be weighing down on riskier assets. Aggregate financing climbed to RMB957.4 billion in August, short of expectations (RMB1135.0 billion), but still a marked improvement after collapsing to RMB273.1 billion in July. A slowdown in credit growth is necessary to ensure the long-term sustainability of the overall economy, and this is a view that the authorities seem to share. However, Capital Economics thinks that, while policymakers are likely to use targeted measures to prevent borrowing costs for small and private firms from rising to rapidly, they will not engage in any significant monetary easing.

On the local data front yesterday, both mining and manufacturing production data for July disappointed against expectations. Mining production fell -7.7% in y/y terms (Bloomberg consensus: -6.7% y/y), with the move towards normalisation of PGM production, following the end to strike action in June, coming through perhaps slower than analysts had expected. The m/m seasonally adjusted change in PGM production was only 0.6%. This meagre growth was compounded by unfavourable base effects (growth of 20.8% m/m sa was recorded in July 2013) resulting in PGM production falling -45.2% y/y, which subtracted 3.0 percentage points (pps) from the y/y headline figure. Gold production also fell significantly, also coming from a pretty high base (13.9% m/m sa up in July 2013); it registered a y/y contraction of -14.6%, which subtracted -0.3 of a pp. Manufacturing production plummeted -7.9% y/y (Bloomberg consensus: -5.8% y/y), weighed down by the impact of the NUMSA-led work stoppages in the metals and engineering sector during July. The effect of the strike can be seen in the -20.4% y/y fall in basic iron and steel, non-ferrous metals products, metals products and machinery category, which pulled the headline number down by -4.1 pps. Downstream activities were also clearly impacted by the strike, with motor vehicles, parts and accessories and other transport equipment production falling -29.0% y/y (subtracting -2.9 pps). The other notable drag on the overall manufacturing figure was the petroleum, chemical products, rubber and plastic products component, which fell -5.3% y/y, subtracting -1.2 pps. Weak output results are rand negative to the extent that they would speak to export constraints, as well as a central bank that is reluctant to tighten monetary policy. They represent a poor start to Q3:14 GDP performance; GDP grew a meagre 0.6% q/q (saar) in Q2:14 after contracting by 0.6% in Q1:14.

The rand depreciated against the US dollar yesterday for the fourth consecutive day, closing at USDZAR10.97, compared with Wednesday’s close of USDZAR10.93, on the back of a continued risk-off bias in global financial markets, softness in commodity prices, and worse than expected local mining and manufacturing data released by Stats SA. The rand’s depreciation against the greenback occurred into a mixed performance from the dollar against the major crosses, and weakness across all of the commodity currencies and most of the EM currencies we monitor for purposes of this report. The dollar weakened against the euro and the pound, while strengthening against the yen. Sterling regained some ground on set-backs suffered by the Scottish Independence lobby. The rand depreciated against all of the major crosses, with the biggest move seen against the pound (0.7%). The rand gave up the least ground in the commodity currency category, but occupied a middle to lower position in the EM currencies category. The only two EM currencies bucking depreciation were the HUF and the INR. The rand traded between a low of USDZAR10.9035 and a high of USDZAR10.9949. Support from where the rand opened this morning sits at 10.8500, 10.7500, 10.6850 and 10.6300. The first resistance level had sat at 11.0000 and the second at 11.0150, but these were temporarily breached in early trade. The rand was back below 11.0000 at time of writing. The next resistance levels are 11.0500, 11.1200 and then January’s high of 11.3900.

Turning to commodity prices, platinum, gold and copper fell by 0.8%, 0.7% and 0.5%, respectively. Brent meanwhile was more or less unchanged. The ALSI edged marginally lower by 0.1% and the EM MSCI dipped by 0.5 %. The EMBI spread compressed by 1 bp while SA’s 5yr CDS spread widened by 0.3 of a bp. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 0.6%.

Non-residents were net buyers of local equities (ZAR611 million) but were very aggressive net sellers of local bonds (-ZAR3 402 million). Aggressive selling of bonds occurred for the third consecutive day yesterday. Selling of bonds was heavily concentrated in the very long-dated 12+ (-ZAR3 405 million) year segment, followed by the 1-3 (-ZAR449 million) and 7-12 (-ZAR52 million) year buckets. Buying of bonds was seen in the 3-7 (ZAR503 million) year segment. Bond yields rose by between 3 bps (R208, R186 and R214) and 4 bps (R203). The 3x6, 6x9 and 12x15 FRAs rose by 1 bp, 4 bps and 6 bps, respectively.

FI

At today’s government ILB auction, NT is planning to raise up to ZAR800m across the I2025, I2038 and I2050. At yesterday’s non-competitive bond auction, the full allowable auction limits were raised. Market participants were eligible to take up 100% of their allocations in the R2044, while buyers in the R2032 and R2048 were allowed to raise the usual 50% limit. 100% was taken up in the R2044, which raised an additional ZAR650m; the R2032 raised an additional ZAR500m and the R2048 raised an additional ZAR351m.

Turnover volumes rose to ZAR33.43bn yesterday, from ZAR27.23bn the day before. The R186 accounted for 35% of yesterday’s turnover, with the R209, the only other bond to record more than a 10% share, at 16%. Yields across the curve rose by between 1.50 bps and 4.50 bps yesterday as SAGBs continued to follow the trend of the currency. At the front-end, the yield on the R158 and R159 rose by 1.50 bps and 2.00 bps, while the slightly longer-tenor R203 and R204 bonds rose by the largest increments of 4.50 bps each. The yield on the R186 rose by 3.00 bps to 8.20 bps. The longest-dated R2048 rose by 3.00 bps to a yield of 8.89%. These movements resulted in the curve flattening at the front- and mid-segments, while the back end remained unchanged. FRA yields rose yesterday, with longer-dated FRAs increasing by larger increments. Around 9 bps of hikes is priced into the 1x4 FRA for next week’s MPC meeting. However, as we have previously mentioned, 3m Jibar is also 17.5 bps higher than after the July MPC meeting, suggesting that the combination of Jibar and FRAs are pricing in a hike.

Non-residents were significant net sellers of nominal SAGBs yesterday for a total of -ZAR3.4bn. Net selling was recorded three out of the four maturity categories, but was most pronounced at the long-end (12+ yr segment). Foreigners sold -ZAR3.40bn in the 12+ year segment, primarily due to net selling in the R186 (-ZAR2.26bn), while notable outflows were also recorded in the R214 (-ZAR430m), R2048 (-ZAR336m), R2030 (-ZAR327m), R213 (-ZAR254m) and R209 (-ZAR107m). This was partially offset by net buying in the R2032 (+ZAR159m) and the R2044 (+ZAR130m) within this segment. Foreigners sold -ZAR449m in the R159 in the 1-3 year segment. Foreigners meanwhile purchased +ZAR503m in the 3-7 year maturity category due to notable inflows into the R207 (+ZAR492m) and R204 (+ZAR132m).

The US Treasury curve continued to steepen yesterday. The yield on the 2yr note declined by 0.79 of a bp to 0.56% while the 5yr UST remained unchanged from a prior day closing yield of 1.79%. At the longer-end, the 10yr note increased by 0.82 of a bp to 2.55% and the 30yr note rose by 0.50 of a bp to 3.28%.

EM FI and currency markets recorded a mixed performance yesterday, which contrasts with the broad-based selling trend that has dominated these markets over the past few days. At the short-end, 5yr local currency sovereign yields rose by 0.75 of a bp on average, and at the long-end, 10yr yields rose by 0.67 of a bp on average. SA’s FI market recorded a weak performance, and also underperformed relative to the EM average, with the 5yr yield rising by 1.80 bps and the 10yr yield rising by 2.50 bps. Larger moves weaker were recorded across a few other EMs that we monitor for the purposes of this report. In the 5yr space, Hungary recorded the largest move weaker (+8.00 bps), followed by Russia (+6.92 bps), then SA. In the 10yr space, only Russia recorded a larger move weaker than SA (+8.19 bps). A number of EM FI markets strengthened yesterday, including those in Brazil, Turkey, India, Mexico and Thailand.

The rand continued to depreciate yesterday, but larger moves weaker were seen across some of the other EM currencies we monitor for the purposes of our reports. The rand depreciated by 0.34% yesterday, while the Russian ruble led the moves weaker, depreciating by 0.54%. The Brazilian real recorded a 0.40% depreciation and the Turkish lira depreciated by 0.39%. Other EM currencies to depreciate on the day were the Mexican peso (0.29%), the Indonesian rupiah (0.11%) and the Thai baht (0.06%). In contrast, the Hungarian forint (0.29%), Polish zloty (0.07%) and Indian rupee (0.04%) appreciated yesterday.

The monetary policy committee of Bank Indonesia (BI) announced that it would leave its reference rate unchanged at 7.50% at the conclusion of its meeting yesterday. This was in line with Bloomberg consensus forecasts. The Bank noted that its “policy is consistent with efforts to control inflation towards its target corridor of [3.5% to 5.5%] in 2014 and [3.0% to 5.0%] in 2015, as well as to reduce the current account deficit to a more sustainable level”. Indonesia’s latest inflation print for August was recorded at 3.99% y/y, well within the central bank’s target range. In addition, “core inflation was successfully controlled and decelerated slightly to 4.47% [y/y].” Locally, household consumption was flagged as following a downward trend, with weak data prints recorded on the country’s retail sales index and in vehicle sales. BI’s growth forecasts are expected to be in the region of 5.1% to 5.5%, with a bias to the lower side of the range.