MACRO ECONOMIC COMMENTARY – OCTOBER 2020

Author: Morotola Polohane


OVERVIEW

The COVID-19 pandemic is not yet over, nor is the disruption it has caused. Many nations are re-instituting partial or full lockdowns, while others are employing targeted restrictions to contain localised resurgences. Restrictions, in some form or another, are in place virtually the world over. It is obvious, then, that economies are likely to operate below their potential until such time as the health risk has been minimised. The rapid deployment of monetary and fiscal policy instruments, which has done much to stymy economic decline, will continue to be needed to keep economies afloat in this ‘second wave’. Economic activities contracted dramatically on a global scale in the first half of 2020, and employment remains low compared to pre-crisis levels. A recent economic rebound notwithstanding, the rebound of the virus now threatens the momentum and extent of economic recovery. The pandemic undermines the repair of economies.

The International Monetary Fund (IMF) sees the world economy contracting by 4.4 percent in 2020; this is slightly better than the 5.2 percent drop forecast in June. For 2021, the IMF projects the GDP growth rate to rebound to 5.2 percent, down from the 5.4 percent growth rate estimated previously. Among all the significant economies, it is only China’s economic output that is expected to be positive in 2020. Still, some of the key indicators – such as global industrial production, retail sales, export growth, and the composite purchasing managers’ index (PMI) – have improved. Global manufacturing and services PMIs were both in positive territory; however, the manufacturing sector is picking up at a faster rate than the services sector. The latter’s fortunes have been mixed: business services activities are accelerating, but consumer services activities remain in extreme distress. It is fair to say that the global economy will continue to exhibit a recessionary character for as long as the discovery of a vaccine remains an uncertainty.

A LOOK AT THE UNITED STATES (US)

The November 3rd presidential election has been the main item on the country’s agenda in recent weeks. Democrat and Republican policy-makers have not been able to come to an agreement about a massive fiscal package prior to the elections; this remains the case after almost three months. The economic recovery picture is uneven, and the government will clearly have to continue supporting the economy. But the timing and size of the fiscal stimulus depends on who wins the presidential election. If Democrat candidate Joe Biden wins, he will only be inaugurated in January 2021, likely delaying the stimulus deal further. Meanwhile, if Republican President Donald Trump is re-elected, the stimulus package may be enacted much faster. In a sense, it is a matter of ‘the longer the delay, the more likely the economy faces recession’; yet, a potential Democrat administration committed to tackling the rapidly accelerating pandemic would be beneficial in the longer term. The consensus view is that a Joe Biden victory is the favourable outcome, principally because he is expected to be less aggressive regarding tariffs with other nations compared to the current approach of the incumbent, President Trump.

Steady demand continues to boost manufacturing and housing, while services remain depressed. Several housing indicators are above pre-pandemic levels, as the lower interest rates support demand. The outlook of the hotel industry is still bleak, although this is better compared to March levels. For example, in New York, the occupancy level reported earlier in October was hovering around 38 percent, compared to an average of approximately 87 percent in a year with a typical Autumn season (according to lodging data from Smith Travel Research). In terms of the labour market, indicators tracked by Bloomberg show some improvement. Some parts of the economy were returning, or have already returned, to pre-crisis employment levels. Responding to booking patterns stabilising, more than two-thirds of the jobs lost in restaurants and bars have reportedly recovered (based on data from restaurant booking platform, OpenTable). Retail sales were up 1.9 percent, which is stronger than consensus expectations of 0.8 percent. However, the acceleration in daily COVID-19 cases in recent months threatens the pace of this nascent economic recovery. The Federal Reserve System (Fed) is back-stopping the economy with trillions of dollars and’ Chair Jerome Powell believes it will recover faster and stronger if both the monetary and fiscal policy work side-by-side.

A LOOK AT CHINA

China’s economic data reported in the month suggest that the economy’s overall recovery is on an upward path. Demand continues to pick up, with exports increasing to 9.9 percent year-on-year, up from the 9.5 percent increase of a month earlier. Imports rose significantly to 13.2 percent, compared to a 2.1 percent decline in the previous month. The rise in imports was a phenomenon across the board, encompassing agriculture products, raw materials, high-tech products, and consumer goods. Particularly worth noting was the surge in purchases of integrated circuits equipment, as technology companies seek to stockpile what they can as some governments (Brazil, United Kingdom, and India) consider bans or restrictions on materials and supplies from Huawei. Furthermore, the US indicated in August that the temporary general licence offered to its companies to work with Huawei will not be extended beyond 2021, and has since tightened its restrictions. Despite increasing imports, China ’s overall trade balance recorded a surplus, surpassing expectations. However, exports may slow down as a result of renewed restrictions in key trading countries, particularly those facing a resurgence of COVID-19 in Europe.

At home, car sales were 6 percent below pre-pandemic levels, yet they have maintained a steady upward trend since the strict lockdown earlier in the year. Property sales in Tier-1 Cities were 26 percent above pre-pandemic levels in the week of October 23rd. Inventory of steel rebar declined significantly, suggesting that construction activities are on track. The annual Golden Week holiday saw a high turnout – which is surprising, given the closure of international borders and strict enforcement of public health measures – of more than 637 million people travelling. For perspective, this figure is equivalent to 80 percent of the total holiday travellers in the whole of 2019. Still, consumer spending is below pre-pandemic levels, despite the Chinese government’s efforts to increase domestic consumption by distributing discount vouchers, subject to certain thresholds, for particular products. One can speculate that consumers are choosing to spend only on necessity items, demonstrating caution in the wake of pandemic-caused uncertainty.

The financial conditions in China are supportive of the economy performing. Credit growth is ticking up at a faster pace, broad money supply saw 10.9 percent growth year-on-year, and issuance of government bonds remains strong. Central bank policies are expected to remain accommodative to support liquidity conditions. The most startling moment of this past month was surely the Chinese stock market recording an all-time daily high in total value since the previous peak of 2015. The surge followed authorities announcing stimulus measures to cushion economic fallout, a commitment that was enthusiastically welcomed by investors. A cautious word is appropriate here, namely that the peak of 2015 was followed by a crash after regulators imposed restrictions on trading practices.

A LOOK AT THE EUROZONE

In its recent meeting, the European Central Bank (ECB) opted to leave its interest rates and monetary policy unchanged. The ECB’s main refinancing operations, the marginal lending facility and the deposit facility, remain at 0.25 and 0.5 percent respectively, while the Pandemic Emergency Purchase Programme (PEPP) remains in place. The Governing Council is expected to update its economic projections in December, as it carefully assesses the incoming data and risks. In its last update in September, the ECB forecast an 8 percent contraction in the Eurozone ’s GDP in 2020, followed by a rebound of 5 percent in 2021. Further, it expects inflation to be as low as 3 percent in 2020 and 1 percent in 2021. Third-quarter GDP in the bloc was stronger, expanding by 12.7 percent, thereby beating the upper end of consensus. It remains to be seen how GDP is performing in the fourth quarter, but it is likely that recent economic setbacks are hampering the pace of economic recovery. The slump may not be as bad as was witnessed in the second quarter; however, as policy-makers have demonstrated their willingness to spend big to prevent more damage. Despite these gains, output levels among the largest economies in the Eurozone, including Germany, France, Italy, and Spain, are still below pre-pandemic levels.

’Communications from policy-makers appear to hint at more stimulus in the event of the economy losing its current upward momentum. This is, unfortunately, highly likely, given the rise in COVID-19 cases in the region, leading even the biggest economies to re-impose lockdowns. Concerning inflation, this remained stubbornly weak: the latest print was minus 0.3 percent change year-on-year, in line with market expectations and the ECB’s forecast. Core inflation, which the ECB focuses on when implementing its policy decisions, remains at a record low, supported by a decline in energy prices. This is consistent with the expansive monetary policy tools.

A LOOK AT SOUTH AFRICA (SA)

The Minister of Finance, Tito Mboweni, tabled the government’s Medium-Term Budget Policy Statement (MTBPS) in parliament in late October. The broader environment for much-needed debt stabilisation is obviously challenging, yet South Africa’s debt-to-GDP ratio is diverging fast from its emerging market and middle-income peers (EMs). In 2012, the SA and average EM debt-to-GDP ratio was 41 percent and 37 percent, respectively. Looking ahead, the SA debt-to-GDP ratio is expected to reach 90.1 percent in 2023, compared to 69 percent among EMs (according to IMF projections). Earlier projections, presented in the June supplementary budget, had the 2023 projected figure at 86 percent; now, debt is expected to peak at 95.3 percent in 2026. The country finds itself in a peculiar and concerning situation: for the past decade, growth has been on a downward trend, while government spending has been increasing, financed by government borrowing. Now, the need to restore fiscal sustainability is weighing negatively on growth. The MTBPS stated the government ’s intention to freeze public-sector compensation in the next three years, in order to support the path to debt stabilisation. This is promising. Yet, as highlighted in the June commentary, negotiations with labour unions will likely encounter resistance.

Even with the Economic Reconstruction and Recovery Plan presented by President Cyril Ramaphosa, the growth outlook will remain weak. The plan relies heavily on infrastructure development and structural reforms; however, government is yet to show investors that it can implement its proposals and sustain growth. Similar proposals of structural reforms and policies in the past have not always been followed through, or at least not with the required speed. The failure of the SA economy could be, in a word, structural. Growth has been on a downward trend since the global financial crisis, a trend that has been exacerbated by corruption. Further, some institutions have been weakened over the past decade, which enabled the egregious mismanagement of public funds’. Based on evidence presented in the State Capture Commission of Inquiry and elsewhere, it is clear that both a lack of fiscal discipline and outright corruption have led to the collapse of most of the country’s state-owned enterprises (SOEs). Even so, the MTBPS makes provision to continue supporting some of the major SOEs. The national carrier, South African Airways, will receive an additional ZAR 10.5 billion to implement a business rescue plan, and the Landbank has requested more financial support, in addition to the ZAR 3 billion already allocated in the June supplementary budget.

SA must pursue economic reform with speed if it is to reinvigorate the economy. Following the MTBPS, rating agency Moody’s remains unconvinced by the implementation timelines of the proposed structural reforms, citing a lack of details. Fitch Ratings is sceptical about the proposed wage bill savings, worried that it is contingent on tough negotiations with public-sector unions. Both Moody’s and Fitch currently have SA’s credit rating on a non-investment grade, with a negative outlook. Undoubtedly, the path to debt consolidation relies heavily on spending cuts and wage negotiations. The steepening yield curve raises questions about the sustainability of government debt; however, investors still have some reason for hope in SA ’s assets. The South African Reserve Bank (SARB) has reduced its bond purchase programme in recent months, as investors continue to find the country’s debt attractive despite fiscal deterioration. This could be the result of their searching for higher yield or risk-reward compensation scenarios.

Inflation eased to 3 percent in September year-on-year, compared to 3.1 percent in August. The SARB has signalled the possibility of two rates cuts if inflation remains controlled at the lower bound. Yet with money market rates at historic lows, cuts may not be necessary if real yields have to stay positive.

CONCLUSION

The uncertainty around the US presidential election outcome may induce volatility in the market. In the event that President Trump is re-elected, the stock market might benefit from his administration’s corporate tax policies. The current trade policy stance being what it is, a continuation of the same under Trump may force the US dollar to devalue further, relative to other significant currencies, including EM currencies (as mentioned in the August commentary). However, short-term action in the market is at least as hard to handicap as are elections and pandemics; liquidity may continue to explain market momentum more than fundamentals. For long-term investors, the risk-reward trade-off improves as risk assets de-rate. Undoubtedly, the rebound is likely going to be a challenge, and investors need not rush to build up positions.