Inside Insights 30 May 2011

Investment Intelligence|Inside Insights

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

Added on 30 May 2011 @ 11:12 AM

RISK-OFF?

Equity markets picked up last week, but since the beginning of May, world markets seem to have been moving through one of its "risk off" phases. Since the end of the Great Recession, market sentiment has oscillated between periods of optimism about sustained global growth ("risk on" phases) where equities, commodities and emerging markets rally and periods of risk aversion, where US Treasuries and the dollar have been asset classes of choice. Gold has done well in both phases, alternating between its role as a safe-haven (when investors fear further recession and financial chaos), and an inflation hedge (inflation generally being associated with growth and high commodity prices).

The most recent risk aversion period is of course linked to the ongoing sovereign debt crisis in Greece and other peripheral eurozone countries. This crisis has dragged on for more than a year, and despite the announcement of a series of bailout packages, record high yields on Greek, Portuguese and Irish bonds suggest the problem is as acute as ever. The strategy of buying time appears not to have worked. And the risk remains that Greece's problems could spill over to other countries in the eurozone, much as volcanic ash from Iceland disrupted air traffic across the continent last week.

The looming end of quantitative easing, the US Federal Reserve's asset purchase programme is also causing some confusion: if the Fed is going to stop buying bonds, why are bond yields falling? The answer might be that the presence of the Fed in the bond market pushed investors towards other, riskier assets. Now that the Fed is about to withdraw, they are returning to the bond market. The other reason is simply that there is a growing sense that the world economy is running out of steam. New data includes disappointing US durable goods orders, and weekly jobless claims. Japan is still feeling the effects of the March 11 tsunami, which disrupted global supply chains as well.

WHICH WAY FOR INTEREST RATES?

The local economy is chugging along, fairly solidly, but unspectacularly. And certainly unevenly across sectors. Most of the attention is thus on when will the Reserve Bank start hiking interest rates. One place to look for an answer is the Bank's twice-yearly Monetary Policy Review, released last week. It notes that since headline CPI inflation bottomed out in September 2010, food, beverages and transport (fuel) have seen the fastest price rises. The housing and utilities category, which includes electricity costs, has been the biggest contributor to consumer inflation due to its size in the basket. Durable goods inflation was negative throughout this period, reflecting the impact of a strong rand. Services inflation, while positive, reduced over the period. Thus non-durables have been the big driver, including food and petrol. CPI inflation excluding food, beverages and petrol was 3.1% year-on-year in April, compared to the 4.1% headline CPI number.

In other words, inflation pressures are being driven by cost increases, not runaway consumer demand and credit extension. There is little the Bank can do about cost-push inflation. But it has signalled clearly that if these input price increases set of a spiral of higher consumer prices and wages - i.e. so-called second round inflation - that pushes CPI above the 6% threshold for a sustained period, the Bank would act by raising interest rates. Otherwise, given high unemployment and much uncertainty, it is likely to be a wait and see approach.

The market is pricing in a 50 basis points hike in the last quarter of this year: the 6x9 FRA indicates expectations for three-month rates, six months from now (i.e November/December), and is currently at 6.03% compared to the repo rate at 5.5%.

THE WEEK AHEAD

• The petrol price will drop slightly on Wednesday, the first decrease after eight months of increases. The decline is only 2c/l, since lower global petroleum prices were largely offset by a weaker rand during the past month.

• National government finances for April (revenue vs. expenditure) will be released on Monday.

• On Tuesday, the Reserve Bank releases credit extension and money supply data for April. Growth in private sector credit extension (PSCE) declined marginally, to 5.2% year-on-year in March, from 5.5% in February. For April, analysts expect an up-tick to 6.4%.

• StatsSA releases first quarter gross domestic product (GDP) growth numbers on Tuesday. The economy grew by 4.4% quarter-on-quarter (on a seasonally adjusted and annualised basis) in the last quarter of 2010. For the first quarter, growth is expected to have increased to 4.5%. The manufacturing sector benefited from a higher demand for motor vehicles in the first quarter, mining rebounded while consumer spending remained strong. However, the largest sector, financial and business services, is likely to have had a muted quarter, with demand for credit still low and the property market still struggling.

• Kagiso and the Bureau for Economic Research release the manufacturing purchasing managers' index (PMI) for May on Wednesday. The PMI measures the health of the manufacturing sector before official data is released. A reading above 50 index points shows that the sector is expanding. In April, the PMI declined to 56.4 from 57.2, but remained at a healthy level. Global PMI's will also be released this week.

• Naamsa releases new vehicle sales numbers for May on Thursday. Although sales growth slowed significantly in April, from 24.8% year-on-year in March to 11.7%, this had a lot to do with the timing of Easter and other public holidays.

• US markets are closed on Monday. Other global data releases of note this week: eurozone May inflation; US March Case-Shiller house price index, April new factory orders, consumer confidence and unemployment for May; Japan April unemployment and industrial production; Q1 GDP for Australia, India and Canada.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights