Macro economic commentary – January 2019

Author: Morotola Pholohane

The beginning of 2019 saw a noticeable change in the US Fed’s tone on the path of policy rates and balance sheet reduction. Over the course of a single quarter, the Fed went from guiding that there might be four rates hike in 2019, to finally implying two, depending on forthcoming data. The Fed also altered its stance from one of targeting balance sheet reduction to being flexible about the size of its balance sheet. These changes contributed positively to market sentiment towards the end of January, helping global equities to close the month in the black and proving once more that liquidity can trump fundamentals in global financial markets. At its January FOMC meeting the Fed decided to keep the federal funds target rate unchanged between 2.25 percent to 2.50 percent citing the lower unemployment rate and overall inflation remaining below two percent. Meanwhile, the positive impact from President Trump’s tax reforms is starting to fade away judging by the recent fall in the percentage of S&P 500 index companies beating analysts’ earnings estimates. The slowdown in the earnings growth is likely to play tug-of-war with softer monetary policy.

Global growth is taking place at a slower pace, as trade and manufacturing activity tapped the brakes, insufficient demand became evident, and monetary policy in most major advanced economies becomes less accommodative. According to the January edition of the IMF World Economic Outlook, the global economy is projected to grow at 3.5 percent in 2019 and 3.6 percent in 2020, moderating by 0.2 and 0.1 percent below last October’s projections, respectively.

In the Eurozone area, economic activity remained weak, mainly due to capacity constraints, slow global demand, and idiosyncratic shocks. High-frequency economic data continue to surprise on the weaker side mainly driven by sector and country-specific risks. German auto production cuts, a wave of French street protests, bank woes in Italy, and Brexit “no deal” uncertainties are amongst factors that influenced lower growth estimates. Inflation is contained, with inflation expectations hovering below the European Central Bank’s (ECB) target. The ECB has suggested that interest rates would remain at current levels as long as inflation remains below 2 percent. In January it was reported that the latest Eurozone unemployment rate was at 7.9 percent in December 2018, unchanged from the previous month. With the slowing growth, there is little pressure building up for an interest rate hike.

In China, the latest PMI number show a contraction in manufacturing for a second month in a row. Within the PMI index, smaller manufacturers’ reductions continued for the fourth consecutive month and employment deteriorated, which will be of concern to policymakers. The downward pressure on the Chinese economy seems to be mounting. China’s trade exports and imports contracted in December (and were weaker than expected), reflecting the weakening demand amid the global slowdown and the effect of the trade- war related volatility.. The latest print in retail sales softened, industrial production weakened, and infrastructure investment strengthened. The authorities are expected to trigger rounds of monetary and fiscal easing to continue to stimulate growth

With all these developments on the global front, interest rates will likely rise at a slower pace than previously expected, in the face of increased headwinds to global growth. The capital flows to stay moderate, more so in the vulnerable economies.

In line with global trends, the latest monetary statement by the South African Reserve Bank (SARB) showed that South Africa’s real domestic growth has been revised downward to 1.7 percent for 2019 and remained unchanged at 2.0 percent for 2020. The SARB expects the economy to operate below production capacity until 2020, normalising in 2021. The SARB cited that the risk to the growth outlook is on the downside resulting from electricity constraints, weak business and consumer confidence levels, a weakened global backdrop for export-led growth, and increased external vulnerabilities due to the high participation of foreigners in domestic financial markets. South Africa is counted amongst the more vulnerable economies to external shocks because of its high exposure to volatile capital flows. The high level of domestic government debt including contingent liabilities to distressed state-owned companies (SOCs) has increased uncertainties surrounding financial stability of Eskom and its ability to generate consistent power supply. The uncertainties surrounding policy implementations on land redistribution, the SARB mandate, labour market reforms, and corruption still exists. The financial health of the SOCs remains the most significant risk to triggering a negative sovereign credit-rating.

High-frequency data suggest that the economic recovery is still patchy with no evidence of demand pressures on domestic prices. Money supply growth is modest, and PPI decelerated to 5.2 percent in December compared 6.8 percent in the prior month, suggesting no upward pressure to inflation in the near term. The PMI data shows contraction as private sector activity remains subdued.

Credit growth was slightly lower, driven mainly by the slowdown in the private sector while credit extension to households is still positive but lower compared to its level before the global financial crisis. The effect of higher taxes in 2018 and higher fuel prices in most of 2018 could be driving the household credit acceleration. The private sector continues to delay investment, perhaps waiting on the side-lines until after national elections to get political clarity on government policies going forward. Corporates have been expanding but mostly to diversify their revenue offshore. Consumer confidence remains subdued, while business confidence is lower after peaking in the first quarter of 2018 with renewed leadership in government.

The retail sales reported earlier in the month were stronger, said to have been supported by the Black Friday specials. Manufacturing was up 0.7 percent in November after advancing 1.1 percent in a prior month. Recent lower oil price is expected to support recovery in the manufacturing sector. The sector ‘s contribution to the GDP has been falling. The share of manufacturing as the percentage of GDP fell to 12.2 percent in the third quarter of 2018 (it was 14.4 percent in the third quarter of 2008, 16 percent in 2008, and was 21 percent in 1994). The government’s auto-manufacturing incentive plan has been extended to 2035 and likely to support the auto industry which constitutes about 50 percent of the manufacturing sector. The financial incentive plan extension is most likely to attract foreign investors in the industry. A stronger rand may be detrimental to the industry as it may undermine the competitiveness of the sector globally but should support the domestic demand. The local market is, however, constrained due to high unemployment, weak informal sector, and household debt. The uncertainty surrounding power supply, with recent load shedding in December and labour strikes, bear risk to the manufacturing industry.

On the back of weakened domestic growth outlook, heightened local risks, SARB kept the repo rate unchanged at 6.75 percent in its January MPC, a view that we support in the near term.