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JOHANNESBURG — Economist Azar Jammine says the uncertainty around growing fears of full-blown trade wars between the US and other countries (most notably China) are adding turbulence to emerging markets. As a result, Jammine expects the rand to be range-bound between R12.70-R14.00 against the US dollar. Judging by this prediction, South Africa may weather the global trade standoff better than some of its other emerging market peers. But there’s still a lot up in the air, including the ANC’s exact plans regarding changing the Constitution’s Section 25 on property rights and the possible future market reaction. – Gareth van Zyl
By Azar Jammine*
- Seldom has there been so much uncertainty regarding the outcome for the global economy of global monetary policy and the recent escalation of the trade stand-off between the US and other countries.
- As for US monetary policy, July non-farm payrolls recorded a smaller increase than had been expected. However, historical data were revised upwards, leaving the impression that US economic growth remains strong. On the other hand, despite a renewed decline in US unemployment to levels last seen two decades ago, wage increases have not accelerated. Furthermore, the purchasing managers indices relating to the leading economies of the world over the past week have suggested a cooling off of such growth. Consequently, there is still much uncertainty regarding the speed or otherwise with which global monetary policy will be tightened.
- As for the trade tensions, the past week has seen an escalation of fears of an all-out trade war, with the US threatening to impose tariffs on an additional $200bn worth of Chinese imports, only for this to be counteracted by the threat of a retaliatory increase in tariffs on $60bn worth of US imports into China. On the other hand, US concerns relating to China’s seeming retaliatory action to devalue its currency were allayed somewhat by moves taken by the Bank of China to limit the extent of such depreciation. One is therefore still unclear as to whether one is witnessing a negotiating ploy by the Trump administration producing precisely the desired backing down by its trading partner economies, or whether we are in the throes of an escalation of a fully-fledged trade war with potentially damaging consequences for the global economy.
- In each case, there are significant implications for emerging markets, especially South Africa’s economy. A marked slowdown in global growth due to steeper interest rate increases than generally anticipated would lead to a substantial decline in commodity prices and impact negatively on emerging market currencies. Similarly, should the Chinese economy suffer as a result of an escalation of a trade war, commodity prices stand to be negatively affected, also with negative consequences for emerging markets.
- However, in neither case is the outcome certain at this stage to materialise in a destructively negative direction. For this reason, we favour maintaining our view that the Rand will fluctuate in a broad range between R12.70 and R14.00 through to the end of the year, but with no definite direction of appreciating or depreciating sustainably from current levels.
US employment growth weaker than expected in July
Two developments relevant to the South African economy have, emanated from the global financial environment over the past few days, one relating to the strength or otherwise of US economic growth and the other one relating to the potential escalation of a trade war. In regard to the former issue, namely of US and global economic growth, some conflicting signals were received. On the one hand, news of a 4.1% q-o-q annualised growth rate recorded by the US economy in the 2nd qtr, up from 2.2% in the 1st qtr, was released on Tuesday. It was an impressive outcome although not entirely unexpected and reflected the stimulus provided by the tax cuts announced by the Trump administration last year filtering through to benefit US consumers and US business.
On the other hand, the purchasing managers indices of the world’s leading economies, including those of the US (ISM), China and the Eurozone, all softened for the month of July, suggesting that there has been a slowdown in the pace of the global economy since the end of the 2nd qtr. In the case of the Eurozone, the slowdown appears to have already commenced in the 2nd qtr, with GDP growth slowing to just 0.3% q-o-q, or 1.2% annualised, compared with growth of 0.4% or 1.5% annualised in the 1st qtr. Both growth rates have been down on the y-o-y growth rate in excess of 2%.
In the case of the US, the 157,000 increase in US non-farm payrolls for July was significantly less than the 195,000 increase that had been anticipated. However, the unemployment rate declined to 3.9%, close to its lowest level for the past two decades. In addition, the average monthly growth in non-farm jobs over the past three months was a healthy 224,000 per month as a result of the May and June employment statistics having been revised upwards. Especially in the manufacturing sector, the performance in July was quite impressive, with 37,000 new jobs having been created, forming part of an impressive 327,000 manufacturing jobs having been created over the past year. This will no doubt be interpreted as evidence of the effectiveness of President Trump’s economic policies to revive the US manufacturing sector. Importantly however, despite the favourable jobs performance of the past few months, y-o-y growth in US wages remained unchanged at 2.7% in July, which is below the latest CPI inflation reading of 2.9%.
In other words, there is little inflationary pressure emanating from a tighter labour market. In conclusion, one is left unclear as to whether or not US interest rates will need to be raised faster or more slowly and by less than currently foreseen. The immediate response of the Dollar to the July non-farm payrolls figures was rightly to weaken on the belief that the softer than expected figures implied the likelihood of a less punitive increase in US interest rates that might attract money towards the Dollar. However, this was precisely the opposite from the reaction that prevailed earlier in the week when the US GDP figure was reported as being so strong. On a longer term basis, the penchant to increase US interest rates might recede on the grounds that the impact of the tax cuts announced by Trump last year are likely to fade and the US economy to weaken.
The tax cuts also leave behind the legacy of a wide budget deficit (currently 4.2% of GDP) that is likely to exacerbate the high level of US public debt. This is also likely to act against US interest rates rising too sharply. Reflecting the vagaries of sentiment regarding the future conduct of monetary policy in the US, the Dollar has oscillated in a fairly narrow band between $1.15 and $1.18 to the Euro for the past three months, falling to the upper end of that range on the back of news suggestive of weaker economic activity and conversely rising to $1.15 when positive news on economic growth has been reported.
Is Trump rhetoric regarding import tariffs for real or a negotiating ploy?
The second important development over the past week which has been keeping financial markets jittery is the suspicion that the rhetoric put out by President Trump regarding the intention of the US to impose ever more import tariffs on major trading partners, especially China, might simply turn out to be a negotiating ploy. Trump has progressively upped the ante with regard to such tariffs. It began with the imposition of a 25% tariff on imports of steel and aluminium as well as solar panels. This was followed by the threatened imposition of tariffs on imported cars from Europe and Asia. Subsequently, tariffs were imposed on $34bn with of Chinese goods. Subsequently, in response to a retaliation of similar magnitude by China on US goods imported into China, Trump has now threatened to impose tariffs on $200bn with of Chinese goods at the beginning of next month. He has even threatened to go all the way and impose tariffs on virtually all goods from China going to the US, valued at around $500bn.
China in turn responded over the weekend by suggesting that it intends imposing tariffs on $60bn worth of US goods. This caused the Dollar to rebound again this morning as investment funds turned to the safe haven of the greenback and away from emerging market currencies. Until now, markets have been relatively steady notwithstanding the fears of the destructive impact should an all-out trade war break out. This has been interpreted as suggesting that those in the markets believe the rhetoric put out by the Trump administration is nothing more than a negotiating ploy aimed at eliciting concessions from trading partners. This has the potential of leaving Trump looking triumphant in his negotiating strategy. There is an underlying confidence that the potential damage which might be inflicted by a trade war will prevent the players involved in escalating such an event. To some extent, support for this view can be gleaned from the most recent development relating to the Chinese Yuan.
Over the past five weeks, the Chinese authorities have been allowing the Yuan to depreciate progressively against the Dollar. The Chinese currency has lost some 5% against the greenback since the beginning of July and around 7% since the beginning of March. This has irritated Trump who has argued that this is a form of currency manipulation to ward off some of the damaging effects of US tariffs on imports from China. Almost as if to appease Trump, the People’s Bank of China imposed a 20% reserve requirement on traders trying to sell the Yuan which can be interpreted as an intervention to prevent the Chinese currency from depreciating further. This can clearly be seen as possibly supporting the view that the Chinese have been the first to blink. Furthermore, it is interesting to question why the Chinese retaliation to the tariffs imposed by the US on $200bn of Chinese goods has amounted to tariffs of just $60bn on imports from the US. This feeds into the narrative that the impact of tariffs on imports is more detrimental to China than to the US and that the capacity of China to retaliate through tariffs on imports is limited by the much smaller size of US imports into China than those going into the US from China.
Theoretically, a trade war would be more negative for emerging markets
To the extent that China is more vulnerable to the effects of a trade war than is the US, it follows that likewise, commodity prices are particularly vulnerable to an outbreak of a trade war given that such a high level of demand for commodities emanates from China. Should the Chinese growth story be negatively affected by a trade war, this will redound to the detriment of commodity prices. Already one has seen this occurring in respect of a number of key commodities, especially base metals where, for example, the price of copper has declined by some 17% in recent months. In turn, following this logic, emerging markets stand to be particularly adversely affected by such a trade war, should it break out in full.
Conversely, the relative confidence that financial markets more generally appear to be displaying in not reacting quite as badly to the fear of a trade war as one might have expected and for reading into developments simply a negotiating tactic by Trump, feeds into the narrative of emerging markets not, after all, facing a major downturn as one might initially suspect.
In addition, one could argue that if global economic growth were to slow sharply in the wake of a trade war, as intimated by the IMF in its latest global economic review, US interest rates might not, after all, rise as steeply and as rapidly as some might fear. Such an outcome would constrain the likelihood of Dollar strength and emerging markets would not feel the heat of US monetary tightening to the extent that is sometimes feared. In this regard, one must bear in mind that the US is running a current account deficit of no less than $465bn, whilst in contrast the Eurozone is running a current account surplus of this order of magnitude ($484bn). It is very difficult to see how the Dollar can gain too much ground in any case in the face of such huge current account imbalances.
Uncertainty regarding outcomes points to sideways albeit volatile movement for the rand
In conclusion, there are many theories and interpretations of current economic data and developments relating to US trade practices. However, there is also great uncertainty as to the direction in which such developments will pan out and what their implications might be. Under the circumstances, we feel relatively comfortable in our view that the Rand is currently reasonably fairly valued and will simply oscillate in a broad trading range between around R12.70 and R14.00 in the foreseeable future. We have chosen a fairly broad range for the currency to trade in for the very reason that one is likely to see countervailing periods of strength and weakness dependent upon the news flow and the numbers which are released. Obviously, a full-blown trade war would threaten the currency to depreciate beyond R14.00, but it still does appear as though what one is witnessing is a negotiating game between major powers. The unfortunate fallout from such a game is that it is starting to damage business confidence around the world and could therefore end up in accelerating what appears to be a nascent global economic slowdown. The latter in turn would be an unfortunate outcome for the South African economy given that the upswing of 2017 and the first part of 2018 has been pivotal in preventing domestic economic growth from receding and instead has helped it stay above 1% at least. From a financial market viewpoint, the above conclusion suggests that markets should not be unduly negatively affected, but that there is a definite downside bias in the probability of outcomes, especially given the high ratings valuations accorded the world’s major share markets.
- Azar Jammine is the chief economist at Econometrix.