Inside Insights 23 March 2010

Investment Intelligence|Inside Insights

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

Added on 23 March 2010 @ 8:19 AM

Easing up on Quantitative Easing

The announcement on Tuesday that the US central bank, the Federal Reserve, would continue to keep interest rates at near zero levels "for an extended period" supported risk appetite on global markets. In the process, the JSE All Share index came close to breaking through 29,000 points, while the rand strengthened to R7.30/$, close to its long-term support line. Renewed concerns over EU support for Greece, and the possibility of IMF intervention, boosted the rand below R10/€ for the first time since January 2008. The Fed also confirmed that it intended to wind up its $1.25 trillion mortgage-backed securities purchase programme at the end of March. The programme was initiated to drive down long-term mortgage rates (American mortgage rates are typically linked to long-term bond rates, rather than the official policy rate, as is the case in South Africa). Some economists fear that ending the program could lead to mortgage rates rising, which would hamper the fragile recovery in the housing market. But the Fed pointed out that it had been gradually winding down the purchase program without major effects thus far. The decision should thus be seen as a sign of confidence, even if the economy is still weak. The Fed's stance was also confirmed by US inflation data showing that CPI rose by 2.1% year-on-year in February. Core CPI, which excludes volatile food and fuel prices, rose by only 1.3% year-on-year, remaining below the Fed's annual target of 2% due to weak domestic demand. The Bank of England also voted to end its ‘quantitative easing' programme of buying £200 billion of assets, mostly government bonds. The Bank also decided to keep the official bank interest rate unchanged at 0.5%.

Which brings us to local monetary policy. The Reserve Bank's Monetary Policy Committee (MPC) meets this week to decide on interest rates, with a decision expected on Thursday afternoon. With the rand as strong as it is and inflation having surprised on the downside the last few months, the possibility of a rate cut exists. But looking at the forward rate agreement (FRA) market shown on the graph, it is clear that such a move is not expected (it is also interesting to note how the market was way ahead of the MPC in predicting cuts between March and August last year). The consensus view is that the MPC has done enough to stimulate the economy, and that the risks to inflation, from electricity tariffs and other sources, are material. The MPC will have hot-off-the press inflation numbers available on Wednesday and Thursday to aid - or complicate - their decision.

Consumers more confident

Confidence among local consumers increased at the fastest pace in five years according to the latest quarterly consumer confidence index (CCI) from the Bureau of Economic research, sponsored by FNB. The CCI shot up by 9 index points to 15 in Q1 2010, having hit a low point of -4 during Q4 2008. Participants in the CCI survey are asked questions relating to the expected performance of the economy, the expected financial position of their household, and whether the present is an appropriate time to buy durable goods. The latter showed the best improvement, although a majority of respondents still believe that now is not a good time to splash out on durables (which are non-essential goods). Thus, while consumer confidence has improved considerably from the depths of the recession, consumers remain cautious.

The improvement in confidence showed up in real retail sales data for December, which fell by only -1.7% year-on-year. While still negative, retail sales growth showed a clear improvement from the -3.8% (revised) December number, and November's shocking -6.6%. It had been in negative territory every month since February 2009, and very weak since February 2008 as consumers faced the headwinds of high debt levels, stricter bank lending criteria and reduced real disposable income. The latter was itself a consequence of high interest rates, inflation, reduced variable pay and rising unemployment. With unemployment having stabilised in the fourth quarter, interest rates slashed and inflation trending downwards, the situation is slowly reversing itself. However, due to high household debt levels - the debt to disposable ratio is 79% according to latest available data - the consumer recovery is expected to be far milder than previous cycles. Nonetheless, improved consumer confidence and spending will be vital in driving economic growth.

The Week Ahead

StatsSA releases local inflation data for February this week. Consumer inflation is measured by year-on-year changes in the consumer price index (CPI), which will be released on Wednesday. CPI inflation declined in January to 6.2% from 6.3% in December. As the base effect of very low fuel prices in early 2009 recedes, most economists expect the 2010 inflation number to move back to the 3% - 6% target range within the next month or two, and remain there for the remainder of the year as food prices fall, and imported inflation is contained by the strong rand.

Producer price index (PPI) data will be released on Thursday. Year-on-year growth in PPI jumped unexpectedly to 2.7% in January from 0.7% in December. PPI is of course much more sensitive to changes in fuel prices, while higher electricity input costs also played a role. PPI for agricultural products was in negative territory though, suggesting further easing on the food price front for consumers. The strong rand will also have a moderating impact on producer prices.

The local Monetary Policy Committee (MPC) meets this week to decide on interest rates (see above).

The Reserve Bank's Quarterly Bulletin for the fourth quarter of 2009 will be released on Tuesday. Apart from a detailed overview of the state of the local and global economies, the Bulletin also contains important data that economists are keen to analyse every quarter. These include household debt-to-disposable income numbers, as well as detail on the current account. Expressed as a percentage of gross domestic product (GDP), the balance on the current account was in deficit to the tune of 3.2% in the third quarter, from 3.4% the previous quarter. The deficit had narrowed significantly from a peak of 8.5% of GDP due to falling imports and lower dividend payments to foreigners. With the country experiencing massive inflows of capital into bond and equity markets, there seem to be few concerns over this gap for the moment.

StatsSA releases the Quarterly Employment Statistics survey for the fourth quarter of 2009.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights