We’ll soon know who the next US president will be. Markets have already clearly signalled their preference: every uptick of support for Donald Trump in opinion polls has been met with a sell-off, and the S&P500 has fallen to its lowest level since July as the polls narrowed. South African equities have followed the US with the JSE All Share dipping to a level last seen after the Brexit vote.
Mexico, whose economy is heavily dependent on continued free-trade with the US, has seen its currency especially hard hit. Unlike other commodity-producing emerging markets (like South Africa and Brazil), the peso didn’t appreciate against the US dollar this year based on fears of a Trump win. That outcome would be a shock, but it is important to recognise how little influence the US president actually has on economic matters as Congress makes most of the relevant decisions. It is in the realm of foreign policy where the US president has most influence. If Hillary Clinton wins as indicated by the latest polls, she will likely be hamstrung by a Republican-controlled Congress. Even with a popular vote behind her, she might be a lame-duck president from day one. This is possibly also weighing on markets.
Fed getting ready to hike
Monetary policy in the US, as in South Africa, is run independently of the executive and legislative branches of Government, and unlikely to be influenced by the outcome of the election. The Federal Reserve’s monetary policy meeting last week set the stage for an interest rate hike in December. The Fed said that it was waiting for “some” further evidence of continued progress toward its goals of 2% inflation and full employment. Inflation has been creeping up in the past few months, and the Fed expects it to be on target by 2018. Unemployment remains low.
Other economic data - on retail sales, manufacturing and housing - have been mixed but generally point to continued moderate growth. So barring an extremely negative data point or severe market meltdown, a hike next month is likely. Futures markets are pricing in an 80% probability, while US long-bond yields have risen to the highest level since March (though at 1.8%, the yield on the 10-year is still well below the 2.25% starting level for the year). What does this mean for us in South Africa? A stronger dollar will put pressure on the rand. The key issue is not whether there is a hike now, but rather how many hikes there will be after December. If the Fed overreacts, the dollar could surge, placing the rand under tremendous pressure. However, a dollar that is too strong works against the Fed’s objectives and it is therefore unlikely that they will increase rates by too much.
As it is, the rand has done very well over the past three weeks, supported by domestic political developments (the dropping of charges against Finance Minister Pravin Gordhan and the release of the Public Protector’s report on state capture), and firmer prices for our main commodity exports. The gold price is around $1300/oz again, while platinum is close to $1000/oz. Iron ore prices lifted from $56 per tonne to around $66 per tonne. For iron ore, platinum and gold, the prevailing dollar price is still below the 2016 high point. But at $67 per tonne, the price of export thermal coal is at the highest level this year, up from $50 per tonne in January.
Political risks everywhere
Domestic politics do affect currencies. The pound jumped after the High Court in London ruled that the UK government needs parliamentary approval to exit the European Union, meaning that Brexit might not even happen (the Government will appeal). But for the rand, the trend is ultimately determined by expectations for US interest rates, sentiment towards emerging markets and commodity prices.
Inflation outlook better
At current levels around R13.50 per US dollar, the rand is more or less where it was last year. This level is probably weak enough to support exports and tourism, but it creates a bit of a problem for investors. Global equity markets moved sideways in US dollars over the past two years, but local investors benefited from persistent depreciation in the rand to boost offshore returns. No more. Similarly, the large rand-hedge component of the JSE benefited from a weaker rand.
The rand tends to overshoot on the upside and downside, but at the moment the rand-dollar exchange rate is well below the average of R14.50 for the second half of 2015 and the first half of 2016. This is positive for the inflation and interest rate outlook. The rand has gained 15% against the Chinese yuan this year, which is notable given how many consumer goods are imported from China. Government’s Crop Estimates Committee recently projected that farmers would plant 2.4 million hectares of maize for the next growing season, a 26% year-on-year increase. This points to a rebound in agricultural production and downward pressure on food inflation. The oil price has also given back some of its recent gains as it appears less and less likely that oil producers will stick to agreed production cuts.
Lower inflation is positive for consumers, who are currently clearly under pressure. For instance, new passenger car sales were down 9.5% year-on-year in October, according to Naamsa. However, there are signs that the worst is over. From a low of 26 014 units in April, sales have rebounded somewhat to 32 739 in October. Exports of new vehicles remain strong at 32 800 units.
Other recent local economic data continues to be mixed, but still points to a gradual improvement. The Barclays/BER manufacturing purchasing managers’ index (PMI) fell back in October, bucking the global trend. However, the broader Standard Bank/Markit PMI remained above 50 in October, pointing to positive growth. Although based on slightly older data, the Reserve Bank’s leading economic indicator echoed this, by showing an improvement on a year-on-year basis for the first time in three years.
South Africa recorded a trade surplus of R6 billion in September. On a cumulative basis (for the first nine months of the year) the trade balance is in deficit, but at R9.9 billion this is an enormous improvement from R37 billion over the same period last year.
Credit growth picked up somewhat in September. Total loans and advances grew by 6.7% year-on-year, up from 6.2% in August. Corporate credit growth accelerated to 12.6% from 11.4% but household borrowing (adjusted for African Bank) slowed to 3.5% from 3.7%. Instalment credit growth (mainly vehicle loans) is anaemic at 1.4% while mortgage credit growth remains below inflation at 5.3%. The weakness in household credit supports the notion that there will not be further interest rate increases. Higher rates are supposed to suppress borrowing, but there is almost nothing to suppress on the household side. Even if rates aren’t cut soon, the outlook for monetary policy is more favourable. The outlook for fiscal policy unfortunately is less so. The planned fiscal consolidation - closing the budget deficit - is a headwind for the local economy. However, Treasury has been careful not to close the deficit too quickly to avoid tipping the economy into recession. Either way, the continued commitment to fiscal discipline is important for the longer-term health of the economy.
Chart 1: Rand-dollar exchange rate with average
Chart 2: S&P500 and JSE All Share equity indices