Manufacturing production unexpectedly increased in August by 1.5% year-on-year more than reversing the 1.1% decline in July and well ahead of the consensus forecast for a 0.5% decline. The biggest contributor was the “basic iron and steel, non-ferrous metal products, metal products and machinery division”, which increased output by 11.3% on the year and contributed a full 2 percentage points to overall manufacturing growth. The “motor vehicles, parts and accessories and other transport equipment” category was surprisingly weak given the recent pick-up in new vehicle sales, with growth of just 0.6% on the year. The overall data are encouraging, with manufacturing showing month-on-month growth of 0.3% and 1.3% quarter-on-quarter over the three months to end August. The outlook for manufacturing is improving, helped by strengthening global demand and rising commodity prices.
Mining production grew in August by an unexpectedly strong 6.9% year-on-year gaining on the upwardly revised 1.9% growth in July and well ahead of the 0.5% consensus forecast. Mining output increased in August by a substantial 5.3 month-on-month and 1.4% quarter-on-quarter over the three months to end August, signaling a pick-up in momentum. Ten of the twelve mining categories recorded growth, led by diamonds, iron ore and gold, with year-on-year growth of 27.7%, 9.0% and 7.7%. Only copper and building materials suffered declines, of 19.8% and 0.5% respectively. Mining production is being aided by gradually rising global commodity prices, which are well above the decade lows reached in 2016. Iron ore prices are the exception, falling almost 20% since the start of the year, although still well above the lows last year. The outlook for commodity prices is constructive, buoyed by stronger than expected growth in China and potential for increased global infrastructure spending.
While the IMF lifted its growth forecast for the world economy and for most countries, South Africa was one of the few exceptions. In the World Economic Outlook report the IMF cut its forecast for South African GDP growth in 2017 from a previous 1.0% to 0.7%. In its report the IMF stated that it expects South Africa’s growth to remain “Subdued…. as heightened political uncertainty saps consumer and business confidence.” Much rests on the upcoming Medium-Term Budget Policy Statement on 25th October, the potential for further credit rating downgrades and the ANC elective conference from 16th-20th December. The IMF report cited rapidly rising public debt and a lack of fiscal capacity.
Foreign investors purchased a net R3.312 billion of South African equities in the week ended 13th October, the biggest weekly inflow into the equity market in 12 weeks. For the month-to-date net equity investor inflows have climbed to R4.766 billion. While the year-to-date balance remains strongly negative at -R68.59 billion the turnaround over the past fortnight may signal better times ahead. The positive foreign net inflows into the equity market since the start of the month coincide with a rapid rise in the All Share index over the same period from 55,300 to 57,792 a gain of 4.5%. Net bond inflows have been mildly negative in the month-to-date to the tune of -R1.071 billion although positive since the start of the year by R68.452 billion. The net year-to-date effect of bond inflows and equity outflows is a marginal net outflow of -R0.138 billion.
SOUTH AFRICA: THE WEEK AHEAD
Consumer price inflation: Due Wednesday 18th October. Consumer price inflation (CPI), which picked-up slightly from 4.6% year-on-year in July to 4.8% in August, is expected to rise to above 5% in September due mainly to fuel price increases during the month. However, CPI is likely to fall back to around 4.5% by early 2018 helped lower by a continued easing in food price inflation. This is well within the Reserve Bank’s 3-6% target range.
Retail sales: Due Wednesday 18th October. Following a dismal start to the year retail sales have shown signs of life in the past two-to-three month. Retails sales are expected to build on July’s 1.8% year-on-year increase with growth likely to exceed 2% in August. Consumers are benefiting from subdued inflation, lower interest rates and a slight gain in credit extension.
In its World Economic Outlook report, the IMF raised its forecast for world economic growth in 2017 from a previous 3.6% to 3.7%, a solid increase from 3.2% growth in 2016. The IMF report stated that: “The outlook is strengthening, with a notable pickup in investment, trade, and industrial production, together with rising confidence.” However, the report called for structural reforms to increase potential growth rates as the output gap is gradually shrinking. IMF chief economist Maurice Obstfeld noted that: “Not all countries are participating, inflation often remains below target with weak wage growth, and the medium-term outlook still disappoints in many parts of the world.” The IMF also cited geopolitical risks. Besides the North Korean threat, there is growing uncertainty in Europe surrounding Brexit negotiations, Catalan independence and a looming election in Italy. The current high level of political uncertainty is unlikely to disappear over coming months.
In coming weeks, financial market attention will turn increasingly towards the succession race for the chair of the Federal Reserve. The Fed chair, Janet Yellen will end her term in February. President Trump has hinted that he will appoint a new chair rather than follow tradition and nominate the incumbent for a second term. The statistical website PredictIt places the probability of appointment of the following candidates, Jerome Powell, Kevin Warsh and Janet Yellen at 52%, 32% and 10%, respectively. Kevin Warsh who has described the Fed as “Poorly positioned to respond with force, efficacy and credibility” is regarded as the more radical choice. If appointed the Fed would probably adopt a far more rapid normalization in monetary policy. Treasury Secretary Steve Mnuchin has urged Trump to appoint Powell, a current member of the Fed’s board of governors. Powell has consistently supported the Fed’s strategy of gradual normalization of interest rates and its balance sheet. Powell would provide a better guarantee of continuity in current policy.
While the S&P 500 index rises to successive record highs market traders are becoming increasingly nervous and less confident that the rally will last. The CBOE Skew index, which measures the risk of outlier “Black Swan” events of two or more standard deviations below the mean, is close to record levels. The Skew index has been steadily rising since July and is back to its peak levels recorded in May. Jim Paulsen, Leuthold Group’s chief investment strategist cited the Skew index while voicing concern that years of record-setting gains for the S&P 500 index may give way to a market plunge.
The minutes from the Fed’s September policy meeting revealed a lack of consensus on the outlook for inflation. Many participants believed the cyclical pressures associated with a tightening labour market would lead to higher inflation in the medium-term. They attributed the softening in inflation data to idiosyncratic once-off effects that are likely to fade. However, many participants expressed concern that low inflation readings may be due to more persistent structural factors. The Fed will likely be mindful of the Treasury yield curve, which measures the difference between five- and thirty-year yields. The Treasury yield spread has fallen below 93 basis points, near the lowest since the 2008/09 recession. A flattening yield curve is traditionally a sign of a weakening economy. Recessions are normally associated with inverted yield curves. Fed futures attribute a 77% probability of a 25 basis-point fed rate hike in December.
Among the Fed officials who spoke publicly during the week, Boston Fed President Eric Rosengren said he thinks stocks are “fully priced”. Hinting at further rate hikes he added that: “Something we must consider is how much prices are likely to go up if we don’t continue the path of raising rates gradually.” St. Louis Fed President James Bullard hinted at a more circumspect approach stating that: “If you are going to have an inflation target you should defend it. If you say you are going to hit the inflation target, then you should try to hit it and maintain credibility.” In the middle of the road, Dallas Fed President said: “I intend to keep an open mind about removing accommodation in upcoming meetings.”
Producer price inflation (PPI) increased in September by a solid 0.4% month-on-month. However, excluding food, energy and trade, PPI increased a more modest 0.2%. Energy prices spiked in September due to Hurricanes Harvey and Irma but have since stabilized. Consumer price inflation (CPI) increased in September by an elevated 0.5% on the month although core CPI, excluding food and energy, was softer than expected gaining just 0.1% below the 0.2% consensus forecast. Energy prices increased 6.1% on the month. On a year-on-year basis headline CPI accelerated from 1.9% to 2.2% while core CPI remained unchanged at 1.7% below the Fed’s 2% target.
Retail sales grew in September by a solid 1.6% month-on-month rebounding strongly from the soft patch in August when they fell 0.1%. The monthly increase is the largest since March 2015. Retails sales were driven higher by gasoline station sales, which increased 5.8% on the month. Building material and motor vehicle sales were also sharply higher by 2.1% and 3.6% on the month, boosted by restocking following hurricane damage in Texas and Florida. Core retail sales, excluding automobiles, gasoline, building materials and foodservices, also grew strongly by 0.4% on the month after showing no change the prior month.
China’s trade volumes picked up in September recovering from the soft patch in July and August. Export growth increased from 6.9% year-on-year in August to 9.0%. Import growth surged from 14.4% to 19.5%. Although the pick-up is partly attributed to the Golden Week public holiday creating a beneficial base effect in last year’s comparative data, the growth is nonetheless impressive. The sharp gain in imports indicates a strengthening in domestic demand. A large part of the gain is attributed to rising imports of industrial commodities. Inbound shipments of iron ore increased 10.6% on the year to a new record. Encouragingly for iron ore producers, China’s iron ore stockpiles have not increased despite the rise in imports, suggesting strong underlying demand.
China’s producer price inflation (PPI) accelerated from 6.3% year-on-year in August to 6.9% in September. There are signs that rising PPI is feeding through to consumer price inflation (CPI). While headline CPI slowed from 1.8% to 1.6% due to the accentuation in food price deflation from -0.2% to -1.4%, core CPI excluding food and energy picked up from 2.2% to 2.3% close to a six-year high. Elevated inflation data will likely cause the People’s Bank of China (PBOC) to maintain its monetary and regulatory policy tightening bias over coming quarters. China’s credit growth remained steady despite monetary and regulatory tightening measures. Growth in outstanding total social financing, the PBOC’s preferred measure of broad credit, decreased only marginally in September from 13.1% to 13.0%. PBOC Governor Zhou Xiaochuan warned that Chinese companies have taken on too much debt. He urged less financial leverage and fiscal reforms to curb local government borrowing.
Domestic private sector machinery orders excluding ships and utilities, a reliable leading indicator for capital spending, unexpectedly increased in August by 3.4% month-on-month building on July’s solid 8% jump. Machinery orders are consistent with quarter-on-quarter growth of 7% in the third quarter suggesting a strong pick-up in investment spending and brightening prospects for productivity improvements. With Japan’s unemployment rate at just 2.8% sustainable economic growth will become increasingly dependent on productivity improvement. Manufacturing orders surged in August by 16% on the month prompting the government Cabinet Office to upgrade its assessment for the first time in 13 months to “recovery movements can be seen.”
After an early surge in popularity the opposition, led by Tokyo Governor Yuriko Koike and his newly formed Party of Hope, are slipping behind in the opinion polls. The incumbent ruling coalition, led by the Liberal Democratic Party (LDP) and Prime Minister Shinzo Abe, is tipped to win the general election on 22nd October, according to the country’s major newspapers. The improving outlook for the LDP helped the Nikkei 225 index to its highest level in 20 years. The retention of a one-party majority by the LDP would cement a continuation of the Abe administration and its reflationary economic policy.
The situation in Catalonia remains unresolved. Catalan Premier Carles Puigdemont, rather than making a declaration of independence is seeking talks with Spain’s government. Puigdemont is using delaying tactics as any decisive decision to split from Spain would result in the central government taking back control of the region and ruling it directly, in line with Article 155 of the 1978 constitution. Financial markets have been only moderately affected by the Catalan uncertainty, suggesting the probability of actual independence for the region is extremely low. Spain’s parliament is firmly controlled by parties which would be opposed to independence.
Italy’s Lower House of Parliament approved the Rosatellum voting system reform. The bill will go to the Upper House Senate for approval over the next fortnight. The Rosatellum voting system would allow the formation of broad coalitions before a general election. This would hurt the populist 5-Star party, which refuses to join coalition alliances. Luigi Di Maio, the 5-Star candidate for Prime Minister said: “This is a mortal blow to democracy, a violation of democratic laws.” The 5-Star party, which leads many opinion polls, could lose up to 50 seats in parliament if the Rosatellum voting system is passed by the Senate. The passing of the bill would likely prompt a general election as early as March 2018.
Eurozone industrial production increased sharply in August by 1.4% month-on-month its largest gain in a year while July’s growth was revised up from 0.1% to 0.3%. On a year-on-year basis industrial production growth accelerated from 3.6% to 3.8%. There were especially large gains in Germany followed by Italy and Spain, which offset declines in France and the Netherlands. By industrial sector, capital goods production encouragingly led the gains with growth of 3.1% on the month indicative of increased business investment. Even if Eurozone industrial production showed nil growth in September the gains so far in the third quarter (Q3) would result in solid quarter-on-quarter growth of 1.3% in Q3. Upbeat purchasing managers’ indices and European Commission business surveys are consistent with annualised growth in industrial production of close to 6%.
Members of the ECB policy committee are reportedly planning to taper the central bank’s quantitative easing programme at the upcoming policy meeting on 26th October. Reports suggest the ECB’s current asset purchase programme of €60 billion per month will be halved to €30 billion but extended for a further nine months past the original expiry date of December 2017. The accommodative stance mirrors a statement made by ECB President Mario Draghi earlier in the weak that: “Progress towards a durable and self-sustaining convergence of inflation towards our objective is not yet sufficiently convincing.” He also pledged to keep interest rates at their current record low level “well past” the end of the ECB’s bond buying programme. The ECB’s chief economist Peter Praet acknowledged a strengthening economy but noted that inflation remained subdued.
As expected the fifth round of Brexit negotiations ended with very little progress being made. The stumbling blocks were differences on citizens’ rights, the Northern Ireland border and the size of the financial settlement levied against the UK. The lack of progress means the timeline for the start of trade talks has been pushed back to after the European Council meeting on 14th-15th December. With time running out ahead of the 29th March 2019 deadline, expectations are growing that there might eventually be no deal. Meanwhile public sentiment is turning against the original vote to leave the EU. The gap between those who think the UK was wrong to vote to leave the EU and those who think the UK was right, has grown to its highest since the EU referendum.
Industrial production grew in August by 1.6% year-on-year up from 1.1% in July. The marked improvement is largely attributed to the base effect of low year-ago comparative levels in the aftermath of the Brexit vote. However, on a month-on-month basis industrial production also grew, by a steady 0.2%. Manufacturing production was particularly strong, rising by 0.4% on the month well ahead of the 0.2% consensus forecast. Construction output grew 0.6% on the month. The industrial production data has improved the GDP outlook for the third quarter (Q3). In the absence of nil growth in September, Q3 industrial production growth would be close to 0.8% quarter-on-quarter more than reversing the 0.3% contraction in Q2.
FAR EAST AND EMERGING MARKETS
Singapore’s third quarter (Q3) GDP grew by a substantial 6.3% quarter-on-quarter annualised up strongly from 2.4% growth in Q2. On a year-on-year basis GDP growth accelerated from 2.9% in Q2 to 4.6% in Q3 well above the 3.8% consensus forecast. While the economic recovery is showing assigns of broadening out to include the services sector as well as the manufacturing sector, it is the latter which contributed the most. Manufacturing output increased in Q3 by 23.5% quarter-on-quarter annualised and on a year-on-year basis picked up from 8.2% to 15.5%. Given Singapore’s high dependence on global trade the country’s upbeat GDP and manufacturing figures indicate an improving outlook for the world economy.
Taiwan’s exports surged in September by 28.1% year-on-year well ahead of the previous month’s 12.7% growth and the 12.9% consensus forecast. The strong numbers are attributed to solid external demand for technology products and rising commodity prices. By export category, electronics exports increased 20.8%, machinery exports 56.5%, chemical exports 46.6% and basic metals by 34.2%. Taiwan’s export numbers are closely watched as a barometer of the global technology cycle and the overall health of global trade. The strength of Taiwan’s export numbers suggests solid underlying strength, which bodes well for global economic growth.
KEY MARKET INDICATORS (YEAR TO DATE %)
JSE All Share
JSE Fini 15
JSE Indi 25
JSE Resi 20
The rand needs to break through key resistance at R/$13.00, which if broken would target further gains to R/$12.50 and thereafter R/$12.00.
The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
The British pound has broken above key resistance at £/$1.30 promoting further near-term currency gains to a target range of £/$1.35-1.40.
The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.
The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
The Brent oil price has broken above key resistance at $50 and likely to remain in a trading range of $50-60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6000 per ton.
Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.
The break above 54,200 on the JSE All Share index projects an upward move to 60,000 marking a new high for the JSE.
The consensus view is that the economic rebound in the second quarter (Q2), when GDP grew by a larger-than-expected 2.5% quarter-on-quarter annualised, was a once-off.
Forecasts are overly pessimistic. Most economists have lowered their GDP forecasts for the year, citing heightened political and policy uncertainty and an absence of domestic demand. In July, the Reserve Bank cut its GDP forecast for 2017 from 1.0% to 0.5%, before lifting it to 0.6% in September. Its GDP forecasts for 2018 and 2019 were also lowered from 1.5% to 1.2% and from 1.7% to 1.5%.
The latest monthly economic data has been far more robust than expected paving the way for an upside surprise in Q3 GDP growth. Mining production increased in August by an impressive 6.9% year-on-year, its strongest growth since March. Manufacturing production increased 1.5% on the year, also exceeding expectations, marking its first year-on-year gain since March. August retail sales, published on Wednesday, are expected to show year-on-year growth of 2.8% building on July’s 1.8% growth rate. Consumers are benefitting from falling inflation and lower interest rates. Agricultural production is continuing to gather momentum. The government’s Crop Estimates Committee raised its 2017 maize harvest forecast in September by a further 2.2% from its August forecast. The 2017 maize harvest is expected to reach 16.744 million tonnes compared with 7.78 million tonnes in 2016. Agriculture is likely to maintain the 21.2% year-on-year growth it achieved in Q2.
South Africa’s GDP growth is likely to beat forecasts in Q3 and accelerate into year-end and in 2018. Falling inflation and declining interest rates will boost consumer spending and business investment spending.
A shrinking current account deficit will make the rand less susceptible to political shocks and external risk events.
The global economic backdrop is supportive. Synchronised global growth is gaining momentum, positive for commodity prices, export demand and inflows of foreign investment capital.
The sub-Sharan economy, South Africa’s largest trading partner, is expected to rebound from 0.7% growth in 2016 to 2.7% in 2017 and 4.0% in 2018 amid rising commodity prices, higher rainfall, lower inflation and falling interest rates.
South Africa’s political risk is close to its peak and likely to subside after the ANC elective conference in December.
Last week the JSE had climbed for nine consecutive days, registering successive record highs. Equity markets are clearly discounting better times ahead. The economic rebound recorded in Q2 is likely to gain traction over coming quarters providing welcome relief to businesses and households.
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