Macro Economic Commentary – October 2019

Author: Morotola Pholohane

| Confidence in traditional tools for maintaining growth is faltering. Major economies are experiencing lower inflation, lower growth, and falling interest rates. Monetary policy tools are inept in addressing declining growth and inflation, despite a concerted effort by some central banks to stimulate growth and stoke inflation through accommodative policies and alternative policies such as QE. Global growth expectations continue to slow down as several drivers of growth fade.

The IMF made a the fifth-consecutive cut to its 2019 world growth forecast, pegging global growth at 3 percent for 2019 down from 3.2 percent in July. A slower pace of growth leaves the economy increasingly vulnerable to destabilizing shocks. However, with the resumption of Q.E. by the Fed and many central banks, the economy should withstand the risk of recession. It does not mean that recession is not likely, as the slowdown is evident; however, it is not imminent. Economic growth forecasts for Asia are significantly downgraded, with China’s expansion predicted to be less than 6 percent in 2020, adding to more worries about the global economy.

The slowdown is apparent across a wide range of indicators, such as falling PMIs in most economies. The ISM manufacturing PMI data are lower. Historically, an ISM manufacturing index level of below 50 points has been associated with the tail risks of subsequent global equity returns being significantly skewed to the downside. With underwhelming economic data, coupled with heightened political uncertainty, downside risks to global equities persist.

In the U.S., the economy is decelerating but not at a pace that materially raises the risk of stalling. Real GDP for third quarter of 2019 was 1.9 percent, lower than the previous two-quarters of 3.1 and 2 percent, respectively. Consumer spending remained firm. There was a rebound in the housing sector (residential fixed investment), which is now contributing positively to the growth for the first time in six quarters. Also, exports rebounded. The economy is facing a tug of war between the resilient consumer and weakening business investment. The consumers are in good shape, and savings are higher as consumer deleveraged. The consumer spending has been the central pillar of U.S. economic strength in recent times.

Decelerating economic activity has coincided with a marked rise in uncertainty: U.S. funding pressure, Trump’s impeachment, and the 2020 U.S. presidential election, amongst others. Also, the future of Britain in the E.U. remains unclear, with the E.U. agreeing in principle to delay Brexit until the end of January 2020. In the meantime, the British might be set for an early election before the end of 2019 after the lawmakers voted in favour of it following months of Brexit deadlock. The election should be a boost for Prime Minister Boris Johnson, who has been suffering parliamentary defeats on his Brexit plan since his appointment in June. However, the bill for an early poll still needs a stamp of approval from the House of Lords after passing through the House of Commons. Corporate investment will remain considerably depressed as the future remains unclear.

The latest development on the US-China trade deal seems to emerge with renewed positive sentiment. However, the path to a full trade deal is difficult to quantify. What looks apparent is that both U.S. and Chinese exporters are equally unhappy. In China, some manufacturing exporters have been moving their production elsewhere to countries such as Vietnam since 2018, while U.S. companies are starting to seek diversification elsewhere and exporting less. Export numbers have declined significantly since 2018 as a result of trade tensions. President Trump’s trade-related tweets show the parties are making progress in negotiations. In the meantime, companies are cutting on capital expenditure as additional tariffs are depressing corporate profits. There was temporary relief as the Trump administration agreed to suspend further rises in tariffs that were to have been implemented in October in exchange for China agreeing to buy farm products. Hopes are emerging that trade deal might be ready for both Presidents to sign soon, though not in mid- November as it was expected after the APEC summit in Chile was cancelled. President Trump ‘s twitter feed indicates that both countries are working on selecting a new site for both leaders to sign phase one of the deal.

Chinese GDP slowed to annualized 6 percent in the third quarter compared to 6.2 percent in the previous quarter. The growth was lowest recorded since 1992 and below consensus expectations of 6.1 percent. Economic data are a mixed bag with weak retail sales, and robust infrastructure investment offset by the weak manufacturing and property investments. Service value added was higher; however, exports were weaker. China’s in-the-pipeline infrastructure investment continued to pick-up, which should further stimulate public spending to bolster the economy.

Weakness in the Eurozone area has forced the ECB to unleash an open-ended round of asset purchases to revive the bloc’s ailing economy. The refinancing rate is at a record low of zero percent, marginal lending rate at 0.25 percent, while the deposit rate continues to attract negative rates of 0.5 percent. The composite PMI sank to 50.1 points compared to the previous month of 51.9 points. The manufacturing PMI showed contraction while the services PMI dropped for the first time this year. There are no signs that the economy is recovering with a confidence lower across most surveys except countries such as the Netherlands. Business surveys (forward-looking surveys) such as PMI suggest weakness is spreading, particularly in Germany’s economy.

The preliminary GDP growth figure reported in the bloc was 0.2 percent compared to the 0.1 percent consensus expectation. The lower growth rate combined with the slightly higher unemployment reported suggests that the economy is yearning for positive news to prevent it from sliding further. With the outgoing ECB President Mario Draghi ending his term with near-stalled GDP, stagnant prices, growing pessimism outlook, the incoming incumbent, Christine Lagarde, will have considerable pressure to find solutions for the euro area’s malaise. Risks from lower external demand will continue to weigh on manufacturing in the bloc but fare better than in Germany. Forward guidance is to stay put on key rates until the inflation is closer to 2 percent. Further, Draghi urged governments to enact expansionary policies as negative rates are not helping central banks to hit its inflation target.

Domestically, finance Minister, Tito Mboweni, delivered the MTPBS, which painted a bleak picture of the country’s debt. The optimism of returning to the above-average long trend GDP is fading with growth on a downward revision trajectory. The current revised GDP growth outlook is too low, while the fiscus support is constrained to support growth reforms. The revenue projections were significantly revised downwards. The budget deficit stands to widen to 6.2 percent of the GDP in 2020, with lower economic growth, revenue shortfalls, and Eskom shortfalls. Provisions for the financial support for Eskom are contributing to the wider fiscal gap. Perhaps the implementation of structural reforms will be acted upon urgently for the economic vision to be realized.

On the positive side, the government has a prudent debt management process in place. Interest-, refinancing- and inflation-rate, as well as currency management, poses fewer risks to accommodate the accumulated debt. Also, the majority of S.A. debt is in a local currency, making it less vulnerable to exchange rate volatility.

In the meantime, the Minister of Public Enterprise unveiled South Africa’s long-awaited plan to save the debt-stricken state power utility Eskom. The plan includes exposing it to greater competition, lowering fuel costs, increasing renewable-energy output, and selling non-core assets, amongst others.
Moody’s is expected to make its announcement on the S.A. rating opinion early in November 2019, while the Fitch will follow later in the month. S&P and Fitch already have South Africa’s foreign currency status below the investment grade with Moody’s at the lowest investment grade.

The economy is not creating jobs either. The unemployment rate reported in the third quarter was the highest in 11 years. The SARB leading economic indicator still signals a bleak economic outlook ahead, and the unemployment rate continues to rise, pointing to a dire labour market. Confidence is still weak, undermined by policy uncertainty, lack of concrete and credible economic reforms, and a materially deteriorating fiscal outlook.