Inside Insights 1 Nov 2010

Investment Intelligence|Inside Insights

A weekly, in-depth yet concise report on the most important recent market movements and economic developments.

Added on 01 November 2010 @ 10:19 AM

Taking aim at the rand

The rand weakened marginally against the dollar last week, as government placed currency strength in its sights. Firstly, government's new growth plan, announced on Monday, has a competitive exchange rate as one of its cornerstones. The Finance Minister fleshed out this idea in the Medium Term Budget Policy Statement (MTBPS) with a number of concrete steps to achieve a weaker currency, though he emphasised that no "inappropriate short-term" measures would be implemented. Quite simply, even if the government wanted to weaken the rand, it is a very difficult thing to do in the absence of a globally coordinated effort to balance the global economy.

The Minister announced that accumulation of foreign exchange reserves would continue. In other words, the Reserve Bank would sell rands and buy dollars (and pounds, euros, yen etc.) in the open market to prevent the value of the rand from appreciating too much. This is potentially an expensive exercise, and would be funded out of the R30bn tax collection overrun. He also announced a relaxation of controls that prevent capital from being repatriated out of South Africa, the thinking being that releasing money currently ‘trapped' in South Africa would offset some of the inflows. The exchange control limit on individuals will be increased from R4m over an individual's lifetime, to R4m per individual per year. Certain restrictions on emigrants will also be lifted, and local companies will be allowed to expand internationally more aggressively. The restrictions on pension funds investing offshore will also be reviewed.

Regardless of these measures, the big driver of the currency and other financial markets at the moment remains the expectation that the Federal Reserve will start buying hundreds of billions of US Treasuries in early November, in an attempt to lower interest rates throughout the American economy and getting nervous banks to lend again. This move is necessitated by an economic recovery that is running out of momentum, even as unemployment remains high and inflation creeps towards zero (bearing in mind the Fed's target is inflation of 2%). However, the scale of quantitative easing will likely be smaller than thought previously, which put a damper on equity market gains and allowed the dollar to claw back some of its earlier losses.

Inflation surprises again

Consumer inflation fell to 3.2% year-on-year in September, down from a 3.5% expansion in the consumer price index in August, according to StatsSA. Lower prices for food, fuel, vehicles and insurance items were the main drivers. Once again, the inflation rate was lower than expected, with the consensus forecast coming in at 3.4%. This latest figure puts headline inflation at its lowest level since June 2005 and very close to the bottom end of the Reserve Bank's 3% - 6% target range. Producer inflation (PPI) was also surprisingly low, falling to 6.8% year-on-year from 7.8% in August and compared to a consensus expectation of 8%.

What does this mean for interest rates? The Monetary Policy Committee will have to weigh up a number of factors. Inflation is clearly surprisingly low, and the rand remains strong. And unemployment is still rising. According to the latest data, unemployment rose to 25.3% in the third quarter, while the non-agricultural formal sectors shed 301,000 jobs so far this year. Household debt levels remain high. These factors argue for another interest rate cut. The MPC might prefer to wait until its January meeting, though, to gauge the impact of past interest rate cuts. Changes in interest rates work with a 12-18 month lag, which means the full impact of a cut in November won't be felt until late 2011, by which time the economic recovery might have picked up steam. Moreover, the Reserve Bank will also be mindful of some of the risks to the inflation outlook, such as tariff hikes, higher crude oil prices (linked to a weaker dollar) and wage increases that are not linked to productivity increases. Finally, if the steps taken to weaken the rand are successful, higher inflation will eventually result. Economic policy-making is always a tricky balancing act.

For the moment though, the Treasury's estimates in the MTBPS are encouraging. It reduced its forecast for average inflation in 2010 from 5.8% to 4.4%, and it upped its 2010 growth forecast to 3% from 2.3%.

The Week Ahead

• After last week's deluge of data and events, this week promises to be quieter on the local front. Market attention will be focused on the US, where the Federal Reserve's open market committee (the FOMC) will potentially announce details of a resumed programme of quantitative easing. Initial estimates were for the FOMC to spend $2trillion on purchasing Treasuries and other instruments. This expectation, which pushed equity markets higher and the dollar lower, has been scaled back to ‘only' a few hundred billion dollars over the next few months. The US will also hold mid-term elections this week, the outcome of which could limit the Obama administration's ability to implement further fiscal stimulus. Lastly, a number of key data releases will paint a picture of the health of the world's largest economy.

• The BER/Kagiso purchasing managers' index (PMI) for October will be released on Monday. The PMI is a gauge for the health of the manufacturing sector, and is closely watched because it has forward looking components, and also because it comes out a month earlier than official manufacturing data. In September, the index dipped below the key 50 points level to 48.4. Manufacturing and non-manufacturing PMI's from across the world will also be released this week.

• Naamsa will release October new vehicle sales on Tuesday.

• Other global events and data releases of note this week: Australia's and the Bank of England's Monetary Policy Committees meet; US September personal income and consumption, construction, consumer credit, pending home sales and employment data; eurozone September retail sales and producer inflation.

Fairbairn Capital | Old Mutual

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