Inside Insights 28 June 2010

Investment Intelligence|Inside Insights

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

Added on 28 June 2010 @ 10:33 AM

Yuan-upmanship

Last week started off well, following China’s announcement over the weekend to allow greater flexibility in the Yuan. This lifted investor sentiment as it signalled confidence on the part of China’s authorities on the economic strength of that country. For years, China pegged the Yuan against the dollar at a low rate in order to keep its vast export sector competitive. Since 2005, Chinese authorities began to allow a gradual strengthening of the Yuan against the dollar. But the onset of the credit crisis in 2008 interrupted that process; in order to see China through the global recession (successfully, as it turned out), the Yuan was kept in a tight range around CNY6.789/$ (the Yuan is not pegged to any other currency, so when the euro weakened against the dollar, it did so against the Yuan too).

The announcement to let the Yuan appreciate comes ahead of the G20 summit in Toronto, where many believe China was due to come under pressure for unfairly advantaging its exporters. The consensus view is that the Yuan is considerably undervalued, by some estimates as much as 50%. This has contributed to an increasingly unbalanced global economy, where some nations (China, Germany, Japan) export, while others (US, UK, Greece) consume. This is not a sustainable situation, especially with unemployment so high in the traditional importing countries. The Chinese central bank has assured markets that any changes in the value of the currency would be gradual. Otherwise, speculative capital betting on a Yuan appreciation could flood China, possibly limiting the central bank’s control over monetary policy and increasing the possibility of asset bubbles.

What would an “unpegged” Yuan mean? A stronger currency could help curb China’s reliance on exports and strengthen domestic demand, and also keep a lid on inflation, while reducing global imbalances. Exporters in other nations would benefit, as would commodity prices. But much scepticism remains as to how far and how fast China will actually allow its currency to appreciate. It may take many years before the value of the Yuan is truly determined by the market instead of by Beijing.

At any rate, by Wednesday concerns over eurozone banks and more disappointing US data dominated market sentiment again. The credit rating of BNP Paribas, France’s largest bank was downgraded by Fitch while another French bank, Credit Agricole, warned that it would write down €400m on its stake in Greek bank, Emporiki. The US reported disappointing new and existing home sales for May, this after government support measures for the housing market came to an end in April. The housing sector is clearly not ready to stand on its own legs yet, and probably neither is the world economy as a whole.

Households holding up

It’s official: the local household sector is doing better. Previously, we discussed surprisingly high consumer confidence. Demand side data released last week by the Reserve Bank showed that the ratio of household debt to disposable income fell to 78.4% in the first quarter of 2010 from 79.9% in the fourth quarter of 2009. On average, households spent 8.2% of disposable income on servicing debt, down from 8.3% in the previous quarter. Real consumption expenditure grew by an encouraging 5.7% in the first quarter, up from the 1.6 % expansion in Q4 2009. Real disposable income of households accelerated by 5.1% in Q1 2010, up from 2.3% in Q4 2009.

Apart from lower interest rates, household disposable income was boosted by higher earnings. New data from StatsSA show that despite horrendous job losses in the formal sector, labour earnings rose 11.7% in the year to end Q12010. For those lucky enough to hold on to their jobs, average monthly incomes increased by 16.7% over the same period. Household finances were also boosted in real terms by inflation falling steadily over the past year. According to the latest available data, CPI inflation fell to 4.6% year-on-year In May, the lowest level in four years.

Finally, the buoyant economic performance in the first quarter boosted demand for imports, but our exports floundered (possibly as result of ongoing rand strength). The result was a surprisingly large first quarter deficit on the current account, 4.6% of GDP from 2.9% in Q4 2009. At the moment, its all about global risk appetite, but longer-term this bigger current account deficit could make the currency vulnerable to depreciation.

The Week Ahead

• The Reserve Bank releases money supply (M3) and private sector credit extension (PSCE) growth numbers for May on Wednesday. On a year-on-year basis, PSCE growth has been negative for the last 8 months, making this the deepest credit cycle since the 1960s. However, the Reuters consensus forecast suggests credit extension may finally have turned positive in May, partly due to the low base off which the growth number is calculated, and partly because of the increase in consumer demand discussed above, and the fact that banks have gradually eased lending standards. On the other hand, credit demand from companies is expected to remain in the red as there is still very little need to add capacity or extend inventories.

• Also on Wednesday, SARS releases monthly trade account data for May.

• On Thursday, the BER releases the Kagiso manufacturing purchasing managers’ index (PMI) for June. The PMI fell for the three previous months to 51.1 in May, but remains above 50, indicating that conditions in the manufacturing sector are still expansionary, even if the pace of expansion is slowing down.

• On Friday, Naamsa releases new vehicle sales data for June.

• Global data releases of note: PMI’s for all the major industrialized nations and for China; US personal income, spending and consumer confidence for May, house prices for April, and June’s unemployment numbers; Japan unemployment, industrial production and household spending for May; Eurozone money supply, inflation and unemployment.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights