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In this week's bottom line: will oil derail the economy?
15 February 2022
One of the greatest unintended consequences of the past few years is the impact of decarbonisation policy on oil prices. Read more
Contributed by Werner Erasmus
Absa’s purchasing managers index (PMI) rose to 57.1 index points in January from 54.1 in the previous month. The current level is in line with November’s reading, but above the average recorded in the fourth quarter of 2021 and reflects a strong start to the year for the manufacturing sector. The improvement is largely due to a rebound in business activity. The forward-looking index (expected business conditions in six months’ time) painted an even more optimistic picture, rising to an almost four-year high of 71.3 points. The improved reading comes as restrictions aimed at slowing the spread of the pandemic were eased further in December and several trading partners lifted travel bans on South Africa after it exited the fourth wave of Covid-19 infections that ensued following the onset of the Omicron strain. All the major subcomponents of the index excluding supplier performance rose in January. The new sales orders sub-index climbed to 55.5 from 51.7, while the sub-index measuring business activity climbed by almost eight points. While it is difficult to pinpoint the reasons for the stark improvement, the most likely is that future virus surges may not come with the strict restrictions on activity that limit output growth.
New vehicles sales increased by 19.5% year-on-year in January. Sales of passenger cars increased by a notable 26.6% on the year. The vehicle rental industry was responsible for 12.3% of total vehicle sales last month. This is another sign that the tourism sector is recovering, albeit tentatively. Less promising was the 9.3% year-on-year decline in vehicle exports during January. This is, however, expected to pick up through 2022 as major producers plan to introduce new models for the export market. NAAMSA noted in its press report that the new vehicle market is expected to continue its gradual recovery to pre-COVID-19 levels in line with the moderate economic growth forecast for South Africa for 2022, but at a slower pace. The South African Reserve Bank increased its benchmark repo rate by 25 basis points to 4% at its January 2022 meeting due to increased inflation risks. Inflation has been fuelled, amongst others, by record-high fuel prices, rising food and energy costs as well as a depreciating rand exchange rate. Consumer and business sentiment will therefore remain under pressure over the short to medium term while supply chain disruptions, such as the global shortage of semi-conductors, will also continue to hamper new vehicle sales and production during the year. On the positive side, NAAMSA expects the new vehicle market trend over the next three years to be upwards, in close correlation with National Treasury’s projected domestic economic growth outlook, averaging 1.7% for 2022, 2023 and 2024.
SOUTH AFRICA: THE WEEK AHEAD
Contributed by Werner Erasmus
Mining production: Due Wednesday, 9 February 2022. Mining production is expected to ease to 3.5% growth year-on-year in December, according to the Bloomberg forecast, from 5.2% in the prior month. December typically sees a seasonal drop in production. Moreover, the rise in Covid-19 cases globally and lockdown restrictions likely weighed on export demand.
Manufacturing production: Due Wednesday, 9 February 2022. Manufacturing is expected to dip 1.8% year-on-year in December, from a 0.7% fall in the prior month, according to the Bloomberg consensus. Omicron and global supply chain disruptions weighed on the sector in the last month of 2021.
State of the Nations Address (SONA): Due Thursday, 10 February 2022. President Cyril Ramaphosa will deliver the state of the nation address on Thursday and is expected to detail progress by the government in its plans to attract foreign investment and help kick-start an economy still battling to recover from Covid-19. Ramaphosa is also expected to provide some hints of what to expect in the upcoming budget, in particular regarding government’s plans to extend income support to the unemployed.
Contributed by Nick Downing
The oil price continued to surge despite the OPEC + group agreeing to its 8th consecutive monthly increase in production. The price surpassed the 2014 peak of $90 per barrel. While production quotas increased by another 400,000 per day, the cartel is unable to keep up with production. According to an OPEC report, production was lagging by 824,000 barrels per day. The shortfall is blamed on years of under-investment, exacerbated by the growing appetite for renewable energy. The Ukraine crisis is also adding to the oil price rally, especially with oil inventory levels at multi-year lows. The oil price, which has gained by 60% over the past 12 months is one of the main culprits in the world’s inflationary surge, and has the potential to dampen consumer spending, which contributes around two-thirds of GDP in the developed world. Fortunately, oil prices are expected to peak in the second quarter, according to the consensus analyst forecast, with US production set to increase. The view is borne out by the shape of oil price futures, which are heavily in backwardation meaning current prices are higher than contracts maturing months ahead. Meanwhile, there is some respite on the Ukraine front, following President Macron’s diplomatic visit to Moscow. He said Russia’s aggression is about wresting a better deal with NATO rather than invading Ukraine. Forthcoming US and NATO compromises are likely to de-escalate the geopolitical risk premium embedded in the oil price.
Contributed by Nick Downing
The US economy added a much stronger than expected 467,000 new jobs in January, well above the consensus forecast of 150,000. The November and December nonfarm payroll number was also revised higher by an aggregate 709,000. Hourly wages increased in January by a solid 5.7% year-on-year and 0.7% month-on-month. The data, which indicates an increasingly tight labour market and rising wage pressure, prompted a further increase in the 10-year Treasury bond yield as the market digested prospects for more aggressive rate increases from the Federal Reserve. After the data release the interest rate futures market priced in more than five 25 basis point interest rate hikes in 2022. Some analysts are even predicting the inaugural rate hike at the Fed’s policy meeting on 15-16th March could be as much as 50 basis points. The labour participation rate, which measures the number of people who are either working or actively looking for work, nudged higher from 61.9% to 62.2%, although the gain is attributed to an increase in population estimates at the start of the year.
Labour participation remains hamstrung by Covid effects, although as these ease and households run down the savings they accumulated from pandemic relief programmes, the labour participation rate is expected to recover. Elevated wages will also incentivise people to return to the labour market. The response from the bond market and interest rate futures market to the stronger than expected jobs data may be overdone. Besides the anticipated improvement in labour participation, employment data tends to be a lagging indicator, which means jobs growth will continue rising even as the pace of growth in consumer demand begins to slow. While the former will boost wage growth, which is inflationary and a source of concern for the Fed, the expected slowdown in consumer demand, which is already underway due to the fading impact of stimulus payments and a weaker equity market performance, should reduce inflationary pressure to a greater extent.
Consumer spending contributes over two-thirds of US GDP. In this context, it is a potential concern that US consumer confidence fell in January below the low point at the start of the pandemic in 2020 hitting its lowest level since November 2011. The University of Michigan Consumer Sentiment Index fell to 67.2 from 70.6 in December, compared with 79.0 in January 2021. The steep decline over the month is due mainly to the Omicron impact, which peaked on 10th January. However, other factors also contributed, including rising inflation and falling real incomes, and the expiry of pandemic relief. Among the survey respondents, 75% cited inflation rather than employment as the most serious problem facing the economy and 58% anticipated a renewed recession. According to Richard Curtin, chief survey economist, “The Fed is about to raise interest rates to tame inflation…. The danger is that consumers may overreact to these tiny nudges, especially given the uncertainties about the coronavirus and other heightened geopolitical risks.” The potential impact of rising interest rates on the equity market and residential property market, significant sources of wealth for US households, could add further pressure on consumer confidence.
Contributed by Nick Downing
China posted upbeat economic data over the past week. Trade volumes continued to surge, with exports rising in April by 32.3% year-on-year up from 30.6% in March. Exports to Southeast Asian countries were especially strong, rising by 40% on the year. China’s imports also gained by a solid 43.1% on the year, attributed to surging commodity prices but also recovering domestic demand. Consumer spending, the relative laggard in China’s post pandemic recovery, appears to be making a comeback with anecdotal evidence of significant growth in tourism travel and box office expenditure in May’s Labour Day holidays. The Caixin/ISM service sector purchasing managers’ index (PMI) also surged higher in April from 54.3 to 56.3 its highest in five months, indicating increased expenditure on consumer services. In contrast with last year, consumer spending is likely to take over from manufacturing as the main driver of China’s economy in 2021. Nonetheless, the manufacturing Caixin PMI also gained in April from 50.6 to 51.9, contributing to an increase in the composite PMI from 53.1 to 54.7, well above the neutral 50-level which demarcates expansion from contraction. However, Wang Zhe, senior economist at Caixin cautioned against rising inflationary pressures, “In the coming months, rising raw material prices and imported inflation are expected to limit policy choices and become a major obstacle to the sustained economic recovery.”
Contributed by Carel La Cock
Japan’s Consumer Confidence Index fell 2.4 points in January to 36.7 marking the lowest reading in five months. Consumer optimism was softer across all sentiment sectors – Overall Livelihood (-1.8), Income Growth (-1.0), Employment (-4.8) and Willingness to buy durable goods (-2.2). The percentage of respondents expecting prices to rise in the year ahead jumped by 1.2% points to 89.7% in January, while only 2.7% expect prices to go down. Japanese consumers have been tightening their belts since the start of the pandemic reflected in the high savings ratios recorded. In the third quarter of last year, savings edged up to 10.3% from 9.6% in the second quarter. Expectations of higher inflation might prompt consumers to tap into their savings which will help a consumer led recovery. Interest rates remains at historic lows and the Bank of Japan is one of the most dovish central banks in the world, which should bode well for consumer confidence once the pandemic peters out.
Contributed by Carel La Cock
Europe’s economy expanded by 0.3% in the final quarter of the year, putting the single currency bloc back on par with pre-pandemic levels of output. The final quarter of the year proved challenging as the Omicron variant forced governments to implement restrictive measures that hampered the recovery in the services sector and saw economic growth slow from the 2.3% pace achieved in the third quarter. Encouragingly, household spend remained firm, while businesses ramped up their efforts to restock inventories, boosting output for the quarter. Compared to the same quarter in 2020, the eurozone economy was 4.6% larger and grew by 5.2% year-on-year for 2021 according to preliminary estimates. Amongst individual countries, Spain (+2%) reported the highest quarter-on-quarter growth, followed by Portugal (+1.6%) and Sweden (+1.4%), offsetting declines for Austria (-2.2%), Germany (-0.7%) and Latvia (-0.1%). All member states reported positive year-on-year growth with France growing 7% year-on-year in 2021 being the standout. It was the fastest growth experienced by the French in more than half a century, driven largely by consumer spending. France was also less impacted by supply chain bottlenecks compared to its more industrial neighbour, Germany, which aided its outperformance. Spain also reported solid growth for the year at 5%, boosted by its tourism industry, but remains 4% below pre-pandemic levels. Economists expect growth in the eurozone to make a healthy recovery in the first quarter of the year as supply chains return to normal and restrictive measures start to ease, boosting both manufacturing and the services sector.
Contributed by Carel La Cock
UK households have been dealt a double blow; first by Ofgem lifting the price cap on energy bills and then by the Bank of England (BoE) hiking interest rates. The energy regulator announced a steep rise in the price cap on energy bills for households from the beginning of April, with average bills expected to be 54% higher. Ofgem proposed reviewing the price cap quarterly instead of the current twice yearly, which they say will reduce the volatility in energy prices consumers face this year. However, with tensions between Russia and the west rising around military action in Ukraine, natural gas supply from Russia could be curtailed which will see another big jump in consumer prices when Ofgem is expected to reset the cap in October. Since August last year, 28 energy companies have gone out of business, squeezed by soaring wholesale gas prices and low consumer price caps. Chancellor of the exchequer, Rishi Sunak, announced a £9bn relief package to alleviate the pressure of high energy bills on the most vulnerable. However, the Bank of England in the same week piled on the misery by hiking interest rates by 25-basis points, which will impact UK households’ disposable incomes by as much as 2% this year. Rates could have been even higher as the monetary policy committee (MPC) voted five to four against a 50-basis point hike. The MPC adjusted its inflation outlook with a view that inflation will peak at 7.25% in April but will remain above 5% until the end of the year. Arguing for a steeper hike in rates, the minority MPC members noted that the central bank has made repeated inflation forecasting errors in the past year. Furthermore, there were signs that companies are set to raise prices significantly in the coming months and that workers are successfully negotiating higher wages, all adding to inflationary pressure.
In addition, the BoE will reduce its balance sheet by not replacing maturing bonds it holds through its £875bn asset purchasing programme while actively selling £20bn corporate bonds by the end of 2023. The run-off will see £28bn in bonds maturing in March and another £70bn maturing over the next two years. It is expected that the impact from rising rates and tapering QE will slow economic growth in the UK to 1% per year while inflation will be brought back to within the target range of 2% in the next two years.
FAR EAST AND EMERGING MARKETS
Contributed by Carel La Cock
Asian countries are seeing a broad-based economic expansion according to the latest IHS Markit Asia Sector PMI figures. Of the 18 sectors being tracked, no less than 16 increased output in April and 13 indicated higher employment levels. Automobiles and Auto parts saw the quickest growth and maintained the momentum gathered in the last three quarters. Other manufacturing sectors such as chemicals, technology equipment, machinery and equipment and household and personal use chemicals all showed promising growth, outpacing the gains made in March. The April reading of the IHS Markit ASEAN Manufacturing PMI figures also showed a steep rise in output and new orders. Vietnam reported the best growth of the ASEAN nations with their PMI hitting a two and a half year high followed by Indonesia which hit a record high. Business confidence across the region was the strongest in over a year. Service sectors also improved especially in healthcare, transportation, and industrial services, but their recovery is still lagging manufacturing. As the global economy continues to gather pace, the region is well placed to benefit from higher global demand and trade.
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THE BOTTOM LINE
Contributed by Nick Downing
One of the greatest unintended consequences of the past few years is the impact of decarbonisation policy on oil prices. Counter-intuitively, the move away from fossil fuels has rewarded rather than punished the oil and gas industry. Oil prices have rocketed amid a lack of new investment and dwindling supply.
High oil prices are punitive for consumers, affect corporate earnings due to increased production and transport costs, and spark the flames of inflation, which in turn prompts interest rates to rise. In South Africa, the price of petrol has jumped from R14.97 to R19.42 per litre over the past 12 months. It was just R9.90 as recently as 2015. The more households need to spend on fuel the less disposable cash they have for other items. For investors, beware the impact of rising costs on profit margins and the impact this could have on the JSE. Investors also need to beware the response from central banks to the global surge in inflation. Nobody wants a return of the early 1980s when the Reserve Bank pushed the repo rate to 20% in its bid to beat runaway inflation.
It varies by country but on average around half the surge in inflation across the world is attributed to the sharp rise in energy costs. The Brent crude oil price has increased by 58% over the past 12 months and is already up a massive 22% since the start of the year. It was hard to imagine in April 2020 when the oil price briefly went negative that less than 2 years later it would be above $90 per barrel. The million-dollar question for politicians, central bankers, businesses, investors and consumers is where to from here?
Oil inventories are depleted due to stronger than expected demand and weak supply growth. In the US, oil stockpiles have been falling at the fastest pace since 1982. Meanwhile the International Energy Agency predicts global oil demand will grow by 3.3 million barrels per day (bpd) this year, exceeding pre-pandemic levels. The OPEC + cartel has for 8 straight months increased its production quota by 400,000 bpd but many of its member countries cannot keep up. In December, production was behind by over 800,000 bpd. The main culprit is under-investment and insufficient maintenance. To cap it all, the Ukraine crisis has heaped a hefty risk premium onto the oil price, estimated to be as much as $10 per barrel. This unenviable cocktail, unless you’re in the oil business, has prompted some wild forecasts from economists. JPMorgan analysts predict a $150 oil price by 2023. This would be a disaster, even for oil producers as such a high price would lead to recession and a sharp decline in demand. Producers like a high price but one that is sustainable.
There is a huge dispersal in forecasts. Capital Economics forecasts $65 per barrel by end 2023 helped by increased supply. US shale production is beginning to regain momentum. Other factors come into play in the more bullish scenario. The Ukraine risk premium could soon reverse following recent diplomatic breakthroughs. It is increasingly evident that Russia does not intend to invade Ukraine but is using the threat to obtain concessions from NATO, a tactic that appears to be working. Iran, another source of oil price risk, could also provide a positive surprise. A renewal of the 2015 nuclear accord between Tehran and Washington would release a potential 4 million bpd onto the world market. The move towards energy transition has gained considerable momentum. The International Energy Agency, in its latest “net-zero” report, urges energy companies to stop all new oil and gas exploration projects from this year. The urgency for decarbonisation will incentivise exporters of fossil fuels to produce as much as possible over coming years. This race may well cause another breakdown of the OPEC + cartel, which in early 2020 contributed to the oil glut and negative pricing.
In the end, the best medicine for high prices is high prices. High oil prices will lure more investment and increased production, which is already apparent in the US. OPEC + does not want prices to be so high that they destroy demand. If this scenario unfolds, expect the big exporters with large excess reserves like Saudi Arabia, the UAE and Kuwait to ramp up production.
The short-term outlook is very different from the long-term outlook for the oil price. Oil price futures are heavily in “backwardation”, which means spot prices for delivery today are much higher than prices for future delivery. The consensus analyst view is that the oil price will peak before the second half of the year. In the much longer-term, as the world works towards “net-zero”, we will likely look back on the current price surge as part of an inverted “J-curve”, to be followed by a declining trend of structurally lower oil prices.
Inflation watchers can be comforted by the fact that even if the oil price does not pull back but remains stuck at its peak levels, its impact on inflation will still soften due to statistical base effects. Inflation data is not guided by absolute levels but rather by the rate of change. In this context, given the high likelihood of increased oil production over coming months, and the prospect of falling geopolitical risk premia, the energy impact on inflation could create an upside surprise. This would mean lower than anticipated inflation in the second half of the year. Contact your investment adviser to correctly position for this outcome.
*All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
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