SA CPI: "mindful of second-round effects"

FX

Local CPI data for June will be released today. Kim Silberman (SBGS economist) expects headline inflation to remain at 6.6% y/y. This is slightly below consensus, which has the headline figure rising to 6.7% y/y. Petrol’s contribution to CPI fell from 0.82 percentage points (ppts) in May to 0.76 ppts in June, which will shave 0.06 ppts off headline inflation. In addition, Kim anticipates that food inflation may have peaked in May and moderated slightly in June. Countering these declines, Kim has assumed an increase in rental price inflation and owners’ equivalent rent. A continued rise in vehicle and clothing inflation is also assumed. The SARB has intimated that although its forecasts since January have pointed to a breach of the upper end of the target range in Q2:14, a May print as high as 6.6% y/y was not anticipated. We have previously argued that it might not take much of an inflation scare from where things now sit – that is, above the upper end of the target band – to force the Bank to tighten again.

Last week, the SARB took rates up by 25 bps. Also, the Bank raised its headline inflation forecast for 2014 to 6.3% from 6.2%, a reversal of the changes made at the May meeting. Inflation is still expected to remain above the upper end of the target band until Q2:15, notwithstanding a “slight moderation” in Q3:14. A quarterly average peak is still seen as occurring in Q4:14, although this has been revised up to 6.6% from 6.5% – another reversal of the changes made at the May meeting. The forecast for average inflation in 2015 was raised to 5.9% from 5.8%. This had remained unchanged at the May meeting after being lowered from 6.0% at the March meeting following the January hike. The Bank still views the risks to the inflation outlook to be to the upside, although this time it mentioned that these “have increased”. While the exchange rate was mentioned as “remain[ing] a key factor in this regard”, the threat of a “wage-price spiral” seemed to be particularly front of mind this time. The Bank noted last week that it has to “be mindful of second-round effects of supply side shocks”. One signal of this would be an uptick in core inflation. Consensus expects core inflation to move up to 5.6% y/y in June, from 5.5% y/y in May.

Risky assets appeared to take comfort from yesterday’s release of US CPI data. The headline reading was in line with expectations (Bloomberg consensus), holding steady at 2.1% y/y in June. However, core inflation (excluding food and energy) moved slightly lower, to 1.9% y/y from 2.0% y/y – analysts had also expected it to hold steady. Perhaps the drop in the core reading has eased concerns that rising inflation might prompt the Fed to tighten policy sooner than currently anticipated. The consensus is that the Fed will start to hike rates in Q3:15. Yesterday’s numbers would appear to offer an initial confirmation of Fed Chair Janet Yellen’s dismissal of recent climbs in the inflation rate as “noise”. It must be kept in mind that the Fed’s preferred measure of inflation, against which it calibrates policy, is the PCE measure. The PCE numbers for June will be published next week Friday. The May reading for PCE inflation came in at 1.8% y/y, after April’s rise to 1.6% y/y from 1.1% y/y in March. Core PCE inflation stood at 1.5% y/y in May. In her testimony before Congress last week, Yellen also 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%.

The rand strengthened against the dollar for the third consecutive day yesterday, closing at USDZAR10.57, compared with Monday’s close of USDZAR10.60. Local currency appreciation occurred despite a strong performance from the dollar against the major crosses. The rand appreciated alongside a stronger performance from most of the commodity and EM currencies we monitor for the purposes of this report. The dollar strengthened against the pound, the euro and the yen, with the biggest move seen against the euro (-0.4%). Three of the five commodity currencies we monitor – namely the ZAR, the AUD and the NOK – appreciated on the day. The exceptions were the NZD which depreciated and the CAD which remained unchanged. All but one of the EM currencies we monitor for the purposes of this report appreciated on the day. The exception was the IDR which depreciated due to some noise around the release of the country’s election results yesterday. Joko Widodo was announced as the country’s new president, winning the election by a wide margin. However, the main opposition contender, Prabowo Subianto, has rejected the results, withdrawing from the contest earlier yesterday, before the official results were released. The rand was the best-performing currency in the commodity currencies category and took up the middle position in the in the EM currencies category. The rand traded between a low of USDZAR10.5610 and a high of USDZAR10.6405. Support from where the rand opened this morning sits at 10.5500, 10.5250, 10.5000 and 10.4600. Resistance levels sit at 10.6500, 10.7200, 10.7800, 10.8200n and 10.8600.

Turning to commodity prices, gold, Brent and platinum fell by 0.5%, 0.3% and 0.2% respectively. Copper meanwhile rose by 0.2%. The ALSI rose by 1.0% and the EM MSCI rose by 1.1%. The EMBI spread compressed by 3 bps and the SA CDS 5yr spread compressed by 4 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 4.5%.

Non-residents were moderate net buyers of local equities (ZAR505 million) and meaningful net sellers of local bonds (-ZAR892 million) on the day. Selling was seen in the 3-7 (-ZAR1 826 million) and 1-3 (-ZAR210 million) year buckets. Buying was meanwhile seen in the 12+ (-ZAR1 044 million) and 7-12 (ZAR100 million) year segments. Bond yields rose on the day by between 4 bps (R203, R208 and R186) and 7 bps (R214). The 6x9 and 12x15 FRAs both rose by 1 bp, while the 3x6 FRA fell by 1 bp.

In local labour news, as an update on the strike in the metals and engineering sector (which began on 1 July), it has been reported that Numsa agreed yesterday to take the latest offer to their members. The wage offer was proposed by the Department of Labour. Mildred Oliphant, Minister of Labour, recently took over the role of mediation after Numsa and employer boards Seifsa and Neasa found no resolution to the dispute. Lucio Trentini, head of operations at Seifsa, making reference to the 10% wage increase offer in each of the next three years for entry-level workers said, "[t]he rallying call of '10, 10, 10' has been met." For skilled employees, the offer entails an increase of 8% in the first year, 7.5% in the second and 7% in the third. A resolution of the current strike action would be viewed as rand positive in that it might serve to ease any anxieties regarding trade deficit compression, as well as perhaps allay rising concerns over the country’s growth prospects.

FI

The bond market should be quiet until SA CPI is released for June at 10am SA time. Bloomberg consensus is for a print of 6.7% y/y, while Standard Bank is forecasting 6.6% y/y. This follows on from the previous month’s 6.6% y/y. The estimates are skewed slightly to the upside. We expect a below consensus print will likely see bond yields move aggressively lower, while a at consensus print should see limited moves in yields. The potential for the June print to be a peak in inflation, prior to the likely Q3 trough, makes this an especially important print. It is also the first of three CPI prints that the SARB will see before September’s MPC.

Yesterday saw a good auction outcome, after a weak morning saw yields widen across the curve. Local bonds did not follow the currency’s reaction to US CPI (+2.1% y/y vs. consensus of 2.1%), which saw USDZAR move below 10.60. Turnover was boosted by the auction to ZAR26.4bn, led by trade in the R186 (ZAR8.6bn), R2030 (ZAR3.7bn) and R214 (ZAR3.4bn). The entire curve weakened, with the back-end R214 and R2044 seeing the largest moves of 7.0 respectively and 7.5 bps respectively. The benchmark R186 moved 4.5 bps higher.

Yesterday’s nominal government bond auction of the R2030, R214 and R2044 saw demand decline week-on-week. Bids fell to ZAR6.91bn from ZAR8.63bn at the prior auction, for an auction bid/cover ratio of 2.9x; this compares with a bid/cover of 3.7x at last week’s offering. The R2030 was the clear outperformer yesterday, both in pricing and investor interest, receiving 50% of the auction’s total bids, for a bond bid/cover of 3.1x. The R214 attracted 37% of the bids, and the R2044 received the remaining 13%. Investor interest in the R2030 was aggressive, with a small proportion of total successful and fully allocated bids recorded in the bond as noted below. Only the R2030 outperforming relative to market levels at the time. The R2030 cleared at 8.53%, trading in the market at 8.575% at the time. The R214 cleared exactly in line with market trading levels, at 8.86%. The R2044 cleared slightly weaker relative to the market, at 8.935%, against the trading level of 8.915%.

Non-residents were net sellers of nominal SAGBs yesterday, for a total of -ZAR892m. However, both large purchases and sales were recorded across the individual bonds comprising the curve. At the front-half of the curve, the 3-7 year segment recorded net foreign selling of -ZAR1.83bn; notable sales were recorded in the R208 (-ZAR1.57bn), R203 (-ZAR258m) and R204 (-ZAR94m), which was marginally offset by net purchases in the R207 of just under +ZAR100m. The R157 in the 1-3 year area recorded net outflows of -ZAR209m. The 12+ year segment recorded net foreign buying of +ZAR1.04bn yesterday; inflows were recorded into the R186 (+ZAR743m), R2030 (+ZAR603m) and R2032 (+ZAR230m), while net selling was recorded in the R2048 (-ZAR228m), R213 (-ZAR215m), R209 (-ZAR138m) and R214 (-ZAR102m). The R2023 in the 7-12 year category recorded net foreign buying of +ZAR100m.

The US Treasury curve flattened yesterday, as UST yields strengthened overall, after the US CPI print. The yields on the 2yr and 5yr USTs fell by 1.83 bps and 2.32 bps respectively, to 0.47% and 1.65%. At the longer-end, the yields on the 10yr and 30yr notes declined by 0.73 of a bp and 0.65 of a bp, to 2.46% and 3.25% respectively.

EM FI and currency markets delivered a strong performance yesterday. 5yr EM bond yields fell by 1.59 bps on average and 10yr yields fell by 2.07 bps on average. SA’s FI market recorded a poor performance, underperforming relative to its EM peers for a second consecutive day. The 5yr yield rose by 3.50 bps, recording the worst performance in this space, and the 10yr yield rose by 4.00 bps, recording the second-worst performance (behind Indonesia’s increase of 5.00 bps). Following the announcement of the results of Indonesia’s presidential election yesterday, the markets (both currency and FI) have been trading at weaker levels. Russia recorded the best performance yesterday, with the 5yr and 10yr yields rallying by 11.73 bps and 10.87 bps respectively. This follows a significant sell-off in Russian financial markets over the past few days on the back of continued geopolitical tensions between Russia and Ukraine. Poland recorded the second-best performance in the 5yr space, with the yield declining by 3.90 bps and Brazil recorded the best performance in the 10yr space, with the yield declining by 10.80 bps.

EM currencies strengthened on balance yesterday. While most EM currencies moved sideways for most of the (local) trading session, following the release of US CPI, EM currencies strengthened sharply, ending their respective trading sessions at these stronger levels. The rand appreciated by 0.30%, behind stronger appreciations recorded in the Russian ruble (0.71%), Turkish lira (0.58%), Thai bhat (0.42%) and Brazilian real (0.37%). Other EM currencies to appreciate yesterday were the Mexican peso (0.21%), Hungarian forint (0.14%) and Indian rupee (0.09%). Currencies to depreciate yesterday were the Indonesian rupiah (0.29%) and Polish zloty (0.18%).

At the conclusion of its central bank meeting yesterday, the Monetary Council of Hungary opted to reduce the official central bank rate by 20 bps to 2.10%. The monetary easing was 10 bps more than surveyed analysts were forecasting, and the result weighed negatively on their financial markets. However, this was short-lived as the wider EM rally then took Hungarian assets stronger. In its official statement, the Council noted that “while the pace of economic activity is strengthening, output remains below potential”. Concerns remain regarding employment, which despite its decline, remains below its long-term level due to structural factors. Key for the Council, is that “[i]nflationary pressures in the economy are likely to remain moderate for an extended period” likely due to “a degree of unused capacity in the economy”. The Hungarian economy has recorded deflationary prices over the past four months, with the latest CPI inflation print recorded at -0.30% y/y. Hungary’s central bank targets an inflation rate of 3.00%. The Bank began easy monetary policy in August 2012 and has lowered rates by a cumulative 500 bps since then.

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