Macro economic commentary – June 2019

Author: Morotola Pholohane

The World Bank projects that global trade growth in 2019 will be the worst it has been since the global financial crisis. The demand for capital goods has been weak since late 2018. Global trade is also in poor shape according to ten gauges used by Bloomberg, with nine of the indicators registering below their long-run ranges. Trade policy uncertainty remains, although US-China trade negotiations are taking place. At the recent G20 summit, the leaders of the world’s two biggest economies agreed to continue with trade-talks, resulting in a brief improvement in short term sentiment. However, in contrast to last year’s talks, the renewed negotiations have no deadlines imposed. President Trump is unhappy with new tariffs imposed by India on 28 U.S. products and demands the withdrawal thereof. Furthermore, Trump is threatening a trade war with Vietnam. On the other hand, the U.S. has earmarked E.U. products worth USD 4 billion for potential tariffs in an on-going subsidy dispute between Boeing Co. and Airbus S.E.

Elsewhere, the E.U. concluded a trade deal with Mercosur that will end tariffs on 93 percent of exports over time and the remaining 7 percent of trade is to get preferential treatment. The deal is believed to give the E.U. leverage to insist on Paris Agreement climate change goals with a country like Brazil which had been threatening to withdraw from the climate change agreement. The deal was negotiated over 20 years and upholds precautionary principles, which set the standards for the future trade-negotiation deals with other countries. The agreement also demonstrates the complexity that the U.K. will face if it exits from E.U. without a deal in place; it can take an awfully long time to complete trade negotiations.

Notwithstanding trade optimism in some respects, global manufacturing PMI fell in the second quarter, signalling a worsening economic growth outlook. The U.S. manufacturing PMI is slightly above 50 points but at its lowest level since 2009. With disappointing PMI readings across most significant economies such as Japan and Eurozone, global growth forecast was revised lower. In the latest World Bank report on the global outlook, global growth estimates are revised down to 2.6 percent in 2019 compared to the previous forecast of 2.9 percent. Eurozone and Japanese growth were downgraded while U.S. growth forecast is unchanged. The growth in China is now expected to be down from 6.6 percent to 6.2 percent in 2019 and 6.1 percent in 2020 if no further trade tariffs with the U.S. are imposed. China PMI remained unchanged in May, at 50.2 points, while the business confidence is still surprising to the downside.

In the Euro area, the latest GDP reported for the first-quarter expanded; manufacturing PMI disappointed while the composite PMI stabilised, averaging 51.8 in the second quarter. Inflation expectations have declined as economic sentiment deteriorated more than expected in recent months. Both economic and industrial sentiment indices dropped. The consumer sentiment indicator worsened to -7.2 compared to the previous month of -6.5. The confidence index in construction was positive at 7.7 positive and some slight improvement in the retail trade confidence index. Business sentiment weakened, and it is expected to deteriorate. The ECB set to continue with additional stimulus programme if economic conditions do not improve.

In the U.K., the BOE kept the rates unchanged, citing downside risk to growth as the risk to “no-deal Brexit” intensified. The inflation rate was lower to 2.0 percent in May from 2.1 in April. Retail sales contracted in May, partly due to unfavourable weather conditions.

Dovish statements by both the Fed and ECB contributed to increased risk appetite for emerging market assets. Most currencies ended higher, including the rand. A modest recovery is expected from emerging markets, although constrained by subdued investments and weaker structural reforms.

Most major central banks face similar dynamics of inflation below target, low-interest rates and below average historical growth rates. These are in contrast with the historical norm of low-interest rates and higher growth in most economies. More accommodative global policy rates should drive the bond yields lower and growth higher, however, growth is still lower in most regions.

In response to the 2008 GFC, major central banks engineered a massive increase in money supply, and yet inflation remains low. If basic rules of the supply and demand apply, the increase in money supply should have led to higher inflation in the long run. In countries like Zimbabwe, Venezuela, and Argentina, amongst others, an increase in money supply was followed by considerably higher inflation – hyperinflation, in fact. The economist, Milton Friedman, argued that “inflation is always and everywhere a monetary phenomenon”. In short, shifting trends in money supply should have an impact on inflation. However, if the money supply growth is supported by real economic output, the price level should be the same. That inflation has remained low suggests more of the latter.

While central banks increased the supply of money post the GFC, banks nevertheless did cut back on lending, shrinking credit massively. Central banks tried to offset shrinking credit with the supply of even more money. Large amounts of additional money went towards buying financial assets, resulting in financial asset inflation rather than the traditional goods and services inflation.

Globalisation has also helped in keeping down inflation in goods and services. Growing demand can be satisfied by the importation of products from countries that produced them at a lower cost. Some attribute low inflation to the credibility of the U.S. Federal Reserve. Both economists and the Fed are surprised that inflation is not as high as they expect it to be regardless of the excessive supply of money. Digital transformation could also be a contributor to lower inflation. It has resulted in increased transparency and has been a counter for lacklustre productivity. The results are increased economic activities and higher economies of scale without putting substantial upward pressure on prices. On-demand technologies such as Uber technologies; digital media and video content such as Netflix depresses the cost of labour and hence lower price pressures if not disinflationary. It could be that the enormous structural shifts introduced by the digital transformation are changing the dynamics of inflation and growth.

Domestically, in line with the global trend, the latest PMI still points to an economy that is under pressure. Business activity and new sales orders remained below 50 levels. Growth has been revised downwards in the latest World Bank report to 1 percent (previous 1.5 percent) in 2019 and 1.5 percent (previous 2 percent) in 2020. In the second quarter, we learned that first-quarter GDP was down 3.2 percent, with the agriculture, mining and manufacturing sectors been the most significant negative contributors. During the first quarter, political uncertainty was high in the run-up to elections; in the face of on-going strike action in the mining sector; and in light of persistent load shedding. All these factors, combined with higher fuel prices, stagnant employment, and lower business confidence, reflect broad-based weakness in the economy. Household consumption declined to 0.8 percent, while the government consumption expenditure increased to 1.3 percent compared to the previous quarter.

Uncertainty regarding Eskom remains, but President Ramaphosa has emphasised government’s unwavering support even as the parastatals continue to struggle financially. While a focus on Eskom is more evident amongst the SOEs, Denel, PRASA, SABC and SAA appear to be further down the totem pole. The majority of these SOEs are struggling with short term liquidity. PRASA and Denel experienced difficulties paying salaries while Eskom and SAA are currently without permanent CEOs.

The economy is not creating jobs either; the SA PMI employment index is lower at a decade low. The
domestic economy is shedding jobs as major corporates are scaling down their workforce due to weak demand or improved efficiencies. In the SONA address, the President highlighted seven key priorities to revive the economy of the country, amongst others, addressing economic transformation and job creation.

For now, at least South Africa retains its investment-grade credit rating with Moody’s with a stable outlook. Moody sees South African risk originating mostly from SOEs and is less worried about financial management in government itself. Sovereign-debt risk, as measured by 5-year CDS, has improved in the year to date from 222.94 to lower level of 168.17 in June. Inflation is within the target and in fact, at the midpoint of the inflation target range. With the latest reported economic data pointing to more average negative factors than positives, the SARB’s and National Treasury’s estimated growth for 2019 might need to be revised downwards.

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