Global repositioning impacts South Africa
By Cees Bruggemans, Chief Economist of FNB.
Looking back over the past three months, the global tide has shifted, also changing our fortunes.
Whether this is just a shake-out or THE cyclical turning time will tell.
The global playout is becoming less problematic growth-wise, also less problematic crisis-wise in Europe, but of late more problematic in the Middle East geopolitically and more problematic inflation-wise in certain regions.
This has invited price pullbacks in global bond, commodity and currency markets, with equities remaining in cyclical recovery, though restrained.
For South Africa it implied selling by foreign investors, allowing our bond yields to rise while equity prices were prevented a quick break into record territory. The Rand pulled back sharply from overextended levels.
All of this started upward revisions to inflation and interest rate perceptions.
Where is this heading?
There are three major triggers driving global repositioning, namely US, European and Chinese prospect revisions (and now Middle East tensions).
Mid-November saw relatively good US data. Fed started QE2 bond buying, reinforcing perceptions of improving prospects. This was further reinforced by President Obama cutting a deal with Republications, increasing fiscal stimulus in 2011.
US growth prospects were revised upwards, bond yields responding by rising 1% towards 3.5%, this example setting in motion similar bond price sell-offs elsewhere.
Meanwhile Ireland went critical, eventually entering the European lifeboat.
Markets increasingly saw the outline of a Germanic assisted overall bailout, incorporating its costs into the German bund, its yield rising by a similar degree as in the US, though for more complex reasons.
As we crossed into 2011, European anxieties moved into the background as China moved centre stage.
In Asia, fast growth and rising inflation, partly commodity induced and partly in places due to a closing output gap or an overstretched resource situation, fed upward revisions of inflation forecasts.
Thus the bond sell-off also spread through emerging markets as bonds globally kept repositioning, demanding higher yields.
China tightened policy controls last year, and raised interest rates twice while allowing a minor controlled appreciation of its currency.
But this was not enough, given excess liquidity, lively credit supply AND demand and commodity price surges.
As more policy action became discounted for 2011, this was assumed to be damaging for the growth outlook, inviting commodity price pullbacks.
These features saw emerging currencies also selling off against the majors, where initial Euro weakness (crisis-induced) became replaced with Euro revival (“Euro-phoria” lifeboat inspired), opposing sentiments driving the Dollar.
The Rand may have been further weakened by fallout from the policy actions of late last year intended to encourage a weaker Rand.
South Africa entered January 2011 at 6.62:$ and is leaving it at 7.16:$.
Historically, this 50-cent move is not very large, though still a pullback to make one pause.
Has the tide turned against us?
When markets reposition like this, the perception can quickly take hold that one great movement has ended and another is beginning.
In this case, have the great forces favouring the Rand reached a high tide mark, now systematically reversing? Or not quite yet?
US growth prospects are slightly better. GDP growth of 3% to 3.5% is expected, with better job growth, but resource slack will take years to meaningfully decline.
US resource use is still low and growth is policy-driven. That could still make for a weaker Dollar, as returns are better elsewhere.
The Euro-crisis seems to have gone into hibernation, awaiting the hinted political reforms and supports. Though this perhaps no longer warrants reckless selling off, fundamental strength is something else. Despite a roaring Germanic core recently, the Euro may still see renewed weakness.
China won’t want to kill off growth. Its comfort zone remains 8-10%. The policy tightening should be seen within that context. Chinese growth may not fall off much, and may see commodity support reviving.
It could be a world that may increasingly come to grips with its worst (crisis and growth relapse) fears, though higher inflation seems to be a reality.
South Africa’s inflation is in any case seen rising from 3.5% now to well over 5% in 2012.
Precious metals may struggle harder if US prospects keep improving and European crisis conditions don’t deepen (but watch the Middle East).
As global markets ‘end’ repositioning, buying into the new global stories (US growth well vested, European crisis subdued, Chinese growth not becalming unduly, with the Middle East still to fully show itself), the impact on us should also became less severe.
Our inflation is in any case heading higher (with global anxieties merely offering upside bias).
Less appetite may be forthcoming for our assets after the exceptional generosity of recent months, with Rand weakness pushing through somewhat more noticeably.
This makes for 6.75-7.50:$ short-term within a 6-8:$ longer range. Bond yields have been upped, equities are marking time, inflation prospects could be upped, the interest rate window may shorten to 3Q2011, and the composition of growth may shift modestly in favour of export producers rather than import consumers.
How long will these ‘new’ positions remain stationary?
Source: Cees Bruggemans, FNB, January 31, 2011.
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