Twin deficit scores this week

FX

Local economic indicators due out this week include employment numbers for Q2:14 from Statistics SA on Monday; the preliminary external trade balance, National Treasury’s statement of revenue and expenditure, and numbers for money supply and credit extension to the private sector (PSCE) - all for August 2014 - on Tuesday; the manufacturing PMI and NAAMSA vehicle sales numbers for September on Wednesday; and the BER’s Consumer Confidence Index (CCI) for Q3:14 on Thursday.

Consensus expects weakness in local employment numbers will persist, forecasting a 0.1% q/q contraction in Q2:14, and no more than a modest uptick in y/y growth of employment to 0.6% from 0.5% in Q1:12. Such an outcome would be consistent with prevailing softness in economic activity and weakness in private sector gross fixed capital formation (GFCF). Private sector GFCF contracted by 1.1% q/q (saar) in 2Q:14, extending a consistently deteriorating trend in place since 4Q:13.

Consensus expects y/y growth of M3 to pick up to 7.0% in August from 6.9% in July. It foresees a deceleration in y/y growth of PSCE to 8.9% from 9.8%. SBGS economist Kim Silberman pins the outcome for PSCE at 9.5% y/y. The bias in the y/y results corresponds with a low base in the case of M3 and a high base in the case of PSCE. In August 2013, M3 rose by just 0.1% m/m on a seasonally adjusted basis; PSCE meanwhile expanded by 1.1%, driven - in turn - by a fairly sharp increase (2.9% m/m unadjusted) in lending to corporates. The base in respect of lending to households is modest (0.2% m/m unadjusted), which limits the space for any downside in the y/y change, although our longer-term prognosis for credit extension to households is for further deceleration, given slowing growth of household disposable incomes, rising local interest rates and a rising number of households that find themselves falling short of lending criteria. Growth of lending to households slowed to 4.1% in July from 4.3% in June; with inflation sitting above 6.0%, it is contracting in real terms. The downdraft in unsecured lending has been especially acute, but growth of instalment sales credit is now at half the levels seen at the start of 2013 (less than 10.0% y/y from close on 20.0%) and mortgage growth has been consistently sub-3.0% y/y since late 2012. The SARB noted in its September MPC Statement that “[t]welve-month growth in general loans to households, which is mainly unsecured lending, reached a low of 0,2 per cent in July, while growth over three months exhibited an annualised contraction of 2,5 per cent. This decline is across all income groups, but more pronounced at the lower levels.” Greater resilience in overall PSCE numbers reflects an acceleration in growth of lending to corporates. Y/Y growth in this segment picked up to 16.3% in July from 13.5% in June. The SARB noted in September that “[g]rowth in corporate sector borrowing during the first half of the year was dominated by the agricultural sector, electricity supply (renewable energy projects) as well as wholesale and retail trade sectors.” However, it appeared concerned about potential impacts here of the recent increase in banks’ funding costs arising from the approach of regulatory deadlines, the Abil debacle and rating action from Moody’s. Weakness in PSCE numbers would likely be read as rand negative largely via any perceived consequences for monetary policy (increased reluctance on the part of the SARB to tighten further), notwithstanding some ambiguity via what it might imply for domestic demand, and thus import demand and the current account.

With respect to the trade balance, the median call is for a widening of the shortfall to -ZAR8.7 billion in August from -ZAR6.9 billion in July. This would be in line with seasonal patterns in the trade balance between July and August. Kim forecasts a deficit of -ZAR12.0 billion. The trade balance deteriorated in August versus July in eight out of the last 11 years. However, there did not appear to be a reliable pattern on either the export or import side of the account. The numbers could perhaps reveal a further modest improvement in precious materials exports, thanks to a gradual normalisation of PGM industry production following protracted strikes in H1:14. However, it is possible that NUMSA-led steel and engineering industry strikes in July could have a delayed impact on manufactured export numbers for August. There is perhaps some adverse risk in the possibility of a reversal in unusually elevated vegetable product export numbers for July. SA’s comparatively wide current account deficit remains the Achilles’ heel of the currency market, and risks are especially pronounced into external financing challenges posed by the prospect of Fed tightening next year and — because of weak local economic growth — a disinclination on the part of the SARB towards more aggressive monetary tightening. Poor 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 significant nominal and real depreciation of the rand exchange rate since late 2012. July 2014 trade results represented a bad start to Q3:14, coming in more than 18.0% wide of the July 2013 outcome. The current account deficit came in at -6.4% of GDP in Q3:13 - its worst point thus far in the cycle. The most recent current account result — that is, for Q2:14 — was -6.2%. Thankfully, the base established in August and September 2013 is pretty wide - at -ZAR11.9 billion and -ZAR11.8 billion respectively — which diminishes the chances that the Q3:13 score will be exceeded in 3Q:14. We think that some of the key ingredients for current account deficit repair are already in play, including a more competitive exchange rate, slowing domestic demand (amplified by pro-cyclical monetary tightening), and improving external demand (albeit uneven and sub-par). Compression of the deficit has been held back by weakness of export performance, due — in turn — not least of all to strikes in export heavy sectors.

Preliminary financing figures published by National Treasury earlier this month point to a fiscal deficit of around -ZAR1.3 billion for August 2014. This would be close to the outcome of -ZAR1.8 billion recorded in August 2013. It sits inside of a consensus forecast of -ZAR2.0 billion. Numbers for the first four months of FY14/15 (that is, up to July 2014) showed government is running moderately behind with respect to revenue performance over the same period in FY13/14; 27.6% of annual budgeted revenue had been collected against 28.2% of actual revenue collected by July 2013. Spending was only marginally behind at 32.4% against 32.5%. Categories of revenue that appear to be falling behind include customs and excise, VAT, company tax and general fuel levy receipts. National Treasury has hinted at the possibility of tax regime changes (including a possible hike in VAT) in February 2015 to shore up revenues into adverse adjustments to its expectations for local economic growth. It is possible that revenues will not miss the target for the current fiscal year by an alarming margin, not least of all because government’s assumption regarding the elasticity of revenues to nominal GDP appears to be conservative. Finance Minister Nhlanhla Nene indicated last month that government now expected GDP growth of only 1.8% in 2014, against a forecast in the February 2014 Budget of 2.7%. Deteriorating domestic economic growth prospects place longer-term revenue objectives perhaps more substantially at risk because they are based on forecasts for a meaningful and sustained acceleration in growth of GDP in subsequent years (to 3.2% in 2015 and to 3.5% in 2016). To the extent that local government elections will take place in 2016, February 2015 could perhaps be viewed as the best time by political leadership for any meaningful tightening of the fiscal purse strings. However, the jury is out as to whether it responds to the need for fiscal restraint from a creditworthiness and thus debt rating and debt service cost perspective, or to the socioeconomic strains inflicted by already tough economic conditions.

Consensus pins the outcome for the September PMI still just above the key expansion/contraction threshold of 50.0 at 50.1, and moderately up on August’s score of 49.0, perhaps on expectations of a continued unwind of strike impacts, including not only July’s NUMSA strikes, but also spillover effects into manufacturing activity of PGM industry work stoppages running till June. The consensus forecast for September NAAMSA vehicle sales numbers is for an easing in the y/y rate of contraction to -0.5% from -1.4% in August. We expect that weakness in the performance of vehicle sales will persist, mainly owing to slowing growth of consumer demand, rising vehicle prices and interest rate hikes. However, the y/y change in vehicle sales for September will be calculated off a low base, which suggests that the room for any downside here is limited; in September 2013, vehicle sales contracted by 3.0% m/m. In its comments accompanying August results, NAAMSA noted some resilience in rental company demand and in commercial vehicle demand. There is no consensus forecast for the BER’s CCI. It bounced to 4.0 in Q2:14 following consistently negative scores over the prior three quarters. This was somewhat surprising, given the continued deceleration in consumer spending, weakness in employment trends, slowing growth of household disposable incomes and elevated domestic inflation. We would not be surprised to see this buoyancy reverse in the Q3:14 result, given in particular a 25 bps interest rate hike from the SARB in July.

As a precursor to the release of tomorrow’s preliminary September CPI numbers for the Eurozone, German states will start to release their September CPI data from this morning culminating in the release of the full national data this afternoon. The consensus call is for a monthly decline of 0.1% to follow the flat number in August (on an EU-harmonised basis). This will leave the annual harmonised rate at 0.7% after 0.8% last time. The harmonised data for Germany are the figures that are plugged into the Eurozone CPI release. The consensus for the Eurozone CPI data is for the annual rate to come down from 0.4% to 0.3%. Steve Barrow (our G10 FIC Strategist) agrees with this call. The threat of deflation keeps the prospect of furthering easing measures from the ECB in play – although no new measures are expected to be announced after this week’s meeting. Easing by the ECB offers some offset to the impact of Fed monetary policy normalisation on emerging market currencies.

The US data schedule is dominated by the September payroll data that looms at the end of the week. Expectations are for a 215k increase, a marked improvement on August’s disappointing 142k increase. The unemployment rate is expected to remain steady at 6.1%. However, before this there’s plenty of other data, starting with personal income and pending home sales today. Of particular interest, perhaps, might be the PCE deflator data, given that this is the Fed’s preferred measure of inflation with regard to policy calibration. The market is looking for the headline deflator to fall 0.1% m/m in August, with the core rate remaining unchanged in m/m terms. Importantly, y/y measures are seen falling, both to 1.4%, but with the headline rate coming down from 1.6% and the core rate from 1.5%. Steve points out that such declines might only serve to bolster the view that price pressures still look very muted indeed even if the economy is looking stronger and the unemployment rate is edging closer to what’s seen as the full employment rate. Steve’s view is that price pressures will stay low, meaning that, when the Fed does start to hike it will have to be confident that either inflation could rise in the future, or that low rates are creating unjustifiable financial excesses that require attention even with price pressures very subdued. Steve expects the first hike in the fed funds rate to occur in Q3:15. This is in line with the median Bloomberg forecast, although a weighted average of analysts’ predictions in the Bloomberg poll has a bias towards Q2:15.

The rand depreciated further against the US dollar on Friday, closing at USDZAR11.23, compared with Thursday’s close of USDZAR11.21. Intraday, the USDZAR broke through the USDZAR11.25 resistance level, spiking to a level of 11.2613, a level last seen at the beginning of February 2014. The rand’s depreciation against the greenback occurred into a strong performance from the dollar against the major crosses, and into weakness across all of the commodity currencies and almost all of the EM currencies we monitor. The dollar strengthened against the euro, the pound and the yen, with the biggest move seen against both the euro and the yen (approximately ±0.5%). The rand appreciated against the euro, the pound and the yen, while weakening against the dollar. As mentioned before, all of the commodity currencies we monitor for the purposes of this report depreciated on the day. All but two of the EM currencies depreciated on the day. The exceptions were the BRL and the INR, both of which appreciated. The rand was the best-performing currency in the commodity currencies category (depreciated the least against the dollar relative to the remaining four commodity currencies) and occupying the middle position in the EM currencies category. The rand traded between a low of USDZAR11.1585 and a high of USDZAR11.2613 on the day. Support from where the rand opened this morning sits 11.1800, 11.1200, 11.0500 and 10.9600. Resistance levels sit at 11.2500, 11.3100, 11.3550 and 11.4000.

With regard to commodity prices, platinum and gold fell by 1.0% and 0.3% respectively. Copper rose by 0.3%, while Brent remained unchanged. The ALSI rose by 0.3%, while the EM MSCI fell by 0.2%. The EMBI spread widened by 1 bp and SA’s 5yr CDS spread widened by 8 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 5.1%.

Non-residents were significant net buyers of local equities (ZAR884 million) and were aggressive net sellers of local bonds (-ZAR1 284 million). Selling of bonds was seen in the 1-3 (ZAR676 million), 3-7 (-ZAR271 million), 12+ (-ZAR196 million) and 7-12 (-ZAR140 million) year buckets. Bond yields rose on the day. The R203 rose by 6bps, and the R208, the R186 and the R214 all rose by 8 bps. The 3x6, 6x9 and 12x15 FRAs rose by 3 bps, 7 bps and 10 bps respectively.

FI

After a very quiet public holiday interrupted week, we expect turnover to increase this week. Bonds are likely to be put on the back foot this week, following last week’s currency moves. With a spate of local data releases this week, global sentiment will be of key importance; weak local data released during a period of poor EM sentiment has a larger market impact than when sentiment is positive.

After a fairly volatile few months, which saw 3m Jibar increase by 15 bps in August and 13.3 bps in July, the rate has only increased by 2.5 bps in September and has been stable at 6.133% over the past 3 weeks. FRAs, however, remain volatile, but have come off their highs after the SARB did not hike rates on 18 September. Over the past five days, the 3x6 and 9x12 points have declined by 14 and 16 bps lower respectively, with slightly smaller incremental moves from other points. The 2x5 point, covering the November MPC meeting is pricing in 15.7 bps of hikes, while the 4x7, covering the November and January 2015 MPC meetings, is pricing in 31.7 bps of hikes. Over the next six months and three MPC meetings, 48.7 bps of hikes is priced in and over twelve months and six MPC meetings, 93.7 bps of hikes is priced in. The FRA curve is currently pricing in 15 – 20 bps of hikes per MPC meeting.

This week is the twin deficit data week for South Africa. Provisional finance figures for August suggest a budget print for the month, of around -ZAR1.30bn. This would take the cumulative year-to-date fiscal deficit to -ZAR105.8bn, compared to the prior fiscal year’s -ZAR98.09bn and 2012/13’s cumulative balance of -ZAR92.4bn. Consensus estimates are penciling in a budget deficit of -ZAR2.00bn. This will be the last formal print before the MTBPS, though we will have provisional September data. We remain concerned that the MTBPS will see negative revisions to growth and revenue.

Local turnover on Friday was recorded at ZAR21.68bn, with a large proportion (ZAR6.10bn) of this contribution stemming from trade in ILBs. On the nominal side, the R186 accounted for a substantial 34% of total nominal turnover, with no other SAGB accounting for more than 10%. The R2032 and the R2048 contributed 9% and 8% respectively. ILB turnover was broad-based, with all bonds recording trades on the day. The R202 recorded the largest proportion of the turnover, with 27% traded in this bond, followed by 16% in the I2046 and 15% each in the I2038 and I2025. These volumes were supported by Friday’s ILB auction.

While local market movements on Friday were fairly benign for a large proportion of the local trading session, a broad-based selloff occurred on the back of a spike in US Treasury yields. This saw yields across the local yield curve close between 4.50 bps to 9.00 bps higher on the day, with the incremental weakening generally increasing with bond tenor. The R158 and the R159 at the very short-end of the curve saw their yields rise by 4.50 bps and 4.00 bps respectively. The R203 and R204 rose by 6.00 bps and 7.00 bps respectively. The extended-maturity R2037 rose by the largest increment of 9.00 bps, while the three longest-dated bonds (R214; R2044; and R2048) rose by 8.50 bps each. The remaining SAGBs comprising the local curve rose by 8.00 bps each. This saw the shape of the belly of the curve remain unchanged on the day, while both the front- and back-ends steepened marginally.

The US Treasury curve flattened on Friday, as yields across the curve rose overall. The 2yr UST rose by 2.37 bps to a yield of 0.57%. The yield on the 5yr UST rose by the largest increment of 4.43 bps to 1.80%. At the longer-end, the 10yr UST note rose by 2.54 bps to 2.53%, while the 30yr note rose by the smallest increment of 0.25 of a bp to 3.21%.

Non-residents were net sellers of nominal SAGBs on Friday for a total of -ZAR1.28bn, with outflows recorded in all four maturity categories. Net selling of -ZAR676m was recorded in the 1-3 year maturity category, primarily due to significant outflows in the R203 (-ZAR698m). The 3-7 year segment recorded net selling of -ZAR271m, with foreigners selling both the R207 (-ZAR169m) and the R204 (-ZAR137m). Foreign selling in the 12+ year segment was recorded at -ZAR196m, with notable outflows recorded in the R186 (-ZAR473m) and the R209 (-ZAR340m); this was offset by foreign buying in the R214 (+ZAR312m), R2044 (+ZAR260m) and the R2032 (+ZAR110m). The R2023 in the 7-12 year segment recorded net foreign selling of -ZAR140m on Friday.

Friday’s ILB auction of the I2025, I2038 and I2050 recorded improved bids compared with the previous week. Pricing was also strong with both the I2050 and the I2038 clearing at better levels compared with Thursday’s closing MTM yields. Total bids increased to ZAR1.67bn from ZAR1.12bn at the previous week’s auction. The full ZAR800m was raised, for a bid/cover ratio of 2.1x (previous auction: 1.4x). Market participation increased, with 24 participants on Friday compared with 19 participants at the prior offering. All three bonds recorded an almost equitable level of investor interest: the I2050 attracted 35% of the auction’s total bids, while the I2025 and the I2038 received the remaining 33% and 32% of investor bids respectively. The I2025 was the only bond to price in line with Thursday’s closing MTM level, at a yield of 1.74%. The I2050 and the I2038 priced stronger; the I2050 cleared at 1.90%, 3.00 bps below Thursday’s MTM yield and the I2038 cleared at 1.87%, 0.50 of a bp below Thursday’s MTM yield.

Due to Wednesday’s public holiday, market participants had until Friday to take up their non-competitive allocations. However, only an additional ZAR268m was raised in the R2032, representing 30% of the total amount raised on Tuesday; the bond was eligible to raise its full allowable limit of 50%. The R2037 and R2044 did not attract any additional funds. However, with ZAR1.00bn on offer in the R2044 at tomorrow’s offering, the non-competitive limit has returned to the default 50%. No SAGBs are currently eligible for the 100% non-comp limit going forward as all bonds in issue will have more than ZAR10.00bn outstanding.

EM FI and currency markets sold off on balance on Friday, in line with the selloff in US Treasuries. At the short-end, 5yr local currency sovereign yields rose by 5.44 bps on average, and at the long-end, 10yr yields rose by 3.77 bps on average. SA’s FI market underperformed in both the 5yr and 10yr tenors. SA’s 5yr and 10yr notes rose by 6.60 bps each, recording the fourth-worst performance overall, relative to its EM peers. In the 5yr space, Turkey (+16.00 bps), Poland (+9.80 bps) and Mexico (+7.70 bps) recorded worse performances to SA, and in the 10yr space, Mexico (+9.30 bps), Poland (+9.30 bps) and Indonesia (+7.90 bps) recorded worse yield moves. India recorded the best FI performance on the day, with its 5yr and 10yr yields declining by 4.00 bps and 4.30 bps respectively. Thailand and Brazil also recorded stronger FI moves on Friday.

EM currency markets depreciated on average on Friday. The exceptions were the Brazilian real (0.32%) and the Indian rupee (0.31%), which both appreciated on the day. The Russian ruble led the moves weaker, depreciating by a substantial 1.78% on Friday, followed by the Hungarian forint (0.69%) and the Polish zloty (0.60%). The Indonesian rupiah (0.54%), Mexican peso (0.45%) and SA rand (0.21%) depreciated relatively less on the day, while the Thai baht (0.14%) and the Turkish lira (0.05%) depreciated slightly.

The outperformance of India’s FI and currency markets on Friday was likely due to the revision of the country’s ratings outlook to stable, from negative, by rating agency S&P.

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