GREATER LIKELIHOOD OF RATE HIKE IN USA DEVELOPING
Brent crude had another volatile week. In the run up to the OPEC meeting next month, Iraq has said they wish to be exempt from cuts in oil production as this would lower their export revenues substantially. Their Minister of Oil, Jabbar al-Luaibi, stated that any cuts to oil production would compromise Iraq’s efforts to fight Islamic State militants. Added to this, data released revealed US crude stocks and production in Nigeria have increased adding to industry over supply concerns which pushed the Brent crude price lower to close the week at $49.35/bbl. The OPEC meeting next month will be closely viewed as to whether it results in production agreements between member countries.
The US 10y treasury yield spiked 9bps over the week to close at 1.85% due to markets having more conviction that the Fed will hike rates in December. Adding to general hawkish rhetoric, San Francisco Fed President John Williams mentioned that if the Fed were to wait too much longer to raise rates, it could mean they would have to hike more aggressively down the line due to run-away inflation (and the potential for market bubbles forming), which would subdue economic growth. He believes a gradual increase in interest rates would be optimal, beginning in December. St. Louis Fed President James Bullard meanwhile said that a December rate hike is now his base case scenario and any move beyond that is likely to be at a gradual pace. The October Markit manufacturing PMI in the US rose to 53.2pts beating expectations of 51.5pts, which was the highest figure since October last year. This was owed to business boosting production as client demand was anticipated to increase in months ahead. The number of Americans claiming unemployment benefits fell to 258k in the week ended 22 October compared to 261k the week before. These positive numbers increase the probability of a Fed rate hike in December.
In Europe, credit ratings agency DBRS kept their rating for Portuguese sovereign debt at investment grade meaning the ECB may still purchase their debt as part of their Quantitative Easing program. DBRS warned that current high levels of public debt, low potential growth and ongoing fiscal pressures are challenges that would need to be addressed. Eurozone preliminary composite PMI for October came in at 53.7pts beating expectations of 52.8pts, which was the highest level for the year and calmed fears of the impact Brexit would have on the Eurozone. Q3 2016 UK GDP reached 0.5% q/q beating expectations of 0.3% q/q, suggesting that growth continues to be broadly unaffected by the vote to leave the EU.
However, Brexit has yet to occur! A strong performance in the services industry offset falls in manufacturing and construction despite that, UK consumer confidence fell -3pts in October from -1pts in September amid increasing pessimism about the economy. The pound has not recovered its losses post the Brexit vote and closed on Friday 17.31% down vs the dollar year to date, at 1.22/USD.
Japanese CPI for September squared with expectations coming in at -0.5% y/y. The Bank of Japan’s new policy to allow inflation to overshoot 2% (target) was not enacted early enough to reflect in the September CPI number so the jury is out as to whether the October CPI could give an indication as to the new policy’s success. The jobless rate for September came in lower than expected (3.1%) at 3.0%, which is back down to twenty-one year lows.
MID-TERM BUDGET SHOWS ECONOMIC WEAKNESS
In the run up to the much anticipated Medium Term Budget Policy Statement (MTBPS) last Wednesday, economic conditions had deteriorated since the main budget was tabled in February, making it more difficult to maintain fiscal consolidation, both politically and economically. As a result, attention was focused on whether the assumptions of revenue growth are credible against the expenditure side that would be relatively inflexible with respect to potential cut backs.
In the event, the 2016 MTBPS saw real GDP growth revised lower by national treasury from 0.9% to 0.5% in 2016, from 1.7% to 1.3% in 2017 and from 2.4% to 2.0% in 2018. This creates a problem come the end of the year as ratings agency S&P would like SA to return to a 3.0% potential growth path. Due to the lower growth outlook, revenue collection is expected to decrease. While practicing austerity, the treasury was also faced with fiscal slippage (unforeseen expenditure), which will necessitate the treasury raising taxes and reducing their spending in other areas, while also drawing down on contingency reserves and allowing the deficit to be larger than initially hoped for in February. The consolidation (debt reduction) targets were revised higher than in the February budget as evidenced by the 2016 target slipping to 3.4% (debt to GDP) vs 3.2%. It further slips to 3.1% vs 2.8% in 2017/2018 and to 2.7% vs 2.4% in 2018/2019 com-pared to the February budget. With the low growth outlook and political uncertainty lowering business confidence in SA, the probability of a ratings down-grade has increased. The higher deficits also mean higher bond issuance at the margin, which is slightly bond negative.
In economic news, September PPI data released by Stats SA came in at 6.6% y/y. This was significantly lower than markets were expecting (7.1%). The main contributors to the positive number, albeit below expectations, emanated from food, beverage and tobacco products while metals, machinery and computing equipment also had a positive effect.
The JSE All Share index closed the week 1.61% down. On the whole, the financial, resource and industrial boards lead the JSE All Share index lower falling -0.99%, -2.82% and -1.43% respectively.