US Federal Open Market Committee (FOMC) signals lower probability of rate cut
20 February 2020
The US Federal Open Market Committee’s minutes of its January 29th meeting was published last night, and reveals the relatively high degree of comfort of the FOMC for leaving interest rates unchanged as per the last dot plot.
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Market implied future possibilities of rate cuts yesterday were for about two 25bp cuts this year.
When US markets open today yesterday’s perceived 85.9% probability of cuts in US interest rates this year is likely to dim, and the rand has already weakened to R15.09/USD, R16.28/EUR and R19.47/GBP this morning from its close yesterday of R14.99/USD, R16.20/EUR and R19.36/GBP.
US interest rate cuts tend to strengthen the rand as it improves the opportunity for yield seeking and so can make EM assets more attractive. SA offers relatively high real yields, although yesterday’s rise in CPI inflation to 4.5% y/y from 4.0% y/y reduced real yields somewhat, and likely also contributed to rand weakness.
Supporting an unchanged US interest rate view, the FOMC minutes revealed that “(p)articipants generally saw the distribution of risks to the outlook for economic activity as somewhat more favorable than at the previous meeting”, with the strong performance of the US economy also bolstering the neutral FOMC view.
The FOMC will remain data dependent as usual, and if data starts to come in which threatens the positive outlook for the US economy, and in particular indicates a weakening in key areas, then the FOMC will likely become significantly more dovish, particularly in its communications, and then in its stance.
The FOMC highlights improvements in some areas including the “easing of trade tensions resulting from the recent agreement with China and the passage of the USMCA as well as tentative signs of stabilization in global economic growth helped reduce downside risks and appeared to buoy business sentiment.”
The FOMC adds that “(t)he risk of a ‘hard’ Brexit had appeared to recede further. In addition, statistical models designed to estimate the probability of recession using financial market data suggested that the likelihood of a recession occurring over the next year had fallen notably in recent months.”
However, “a number of downside risks remained prominent. … participants generally expected trade-related uncertainty to remain somewhat elevated, and they were mindful of the possibility that the tentative signs of stabilization in global growth could fade.”
Furthermore, “(g)eopolitical risks, especially in connection with the Middle East, remained. The threat of the coronavirus, in addition to its human toll, had emerged as a new risk to the global growth outlook, which participants agreed warranted close watching.”
The World Health Organisation (WHO) is working urgently “with an international network of statisticians and mathematical modellers” to better understand “the incubation period, case fatality ratio (the proportion of cases that die) and the serial interval (the time between symptom onset of a primary and secondary case).”
When US markets open today yesterday’s perceived 85.9% probability of cuts in US interest rates this year is likely to dim, and the rand has already weakened to R15.09/USD, R16.28/EUR and R19.47/GBP this morning from its close yesterday of R14.99/USD, R16.20/EUR and R19.36/GBP.
US interest rate cuts tend to strengthen the rand as it improves the opportunity for yield seeking and so can make EM assets more attractive. SA offers relatively high real yields, although yesterday’s rise in CPI inflation to 4.5% y/y from 4.0% y/y reduced real yields somewhat, and likely also contributed to rand weakness.
Supporting an unchanged US interest rate view, the FOMC minutes revealed that “(p)articipants generally saw the distribution of risks to the outlook for economic activity as somewhat more favorable than at the previous meeting”, with the strong performance of the US economy also bolstering the neutral FOMC view.
The FOMC will remain data dependent as usual, and if data starts to come in which threatens the positive outlook for the US economy, and in particular indicates a weakening in key areas, then the FOMC will likely become significantly more dovish, particularly in its communications, and then in its stance.
The FOMC highlights improvements in some areas including the “easing of trade tensions resulting from the recent agreement with China and the passage of the USMCA as well as tentative signs of stabilization in global economic growth helped reduce downside risks and appeared to buoy business sentiment.”
The FOMC adds that “(t)he risk of a ‘hard’ Brexit had appeared to recede further. In addition, statistical models designed to estimate the probability of recession using financial market data suggested that the likelihood of a recession occurring over the next year had fallen notably in recent months.”
However, “a number of downside risks remained prominent. … participants generally expected trade-related uncertainty to remain somewhat elevated, and they were mindful of the possibility that the tentative signs of stabilization in global growth could fade.”
Furthermore, “(g)eopolitical risks, especially in connection with the Middle East, remained. The threat of the coronavirus, in addition to its human toll, had emerged as a new risk to the global growth outlook, which participants agreed warranted close watching.”
The World Health Organisation (WHO) is working urgently “with an international network of statisticians and mathematical modellers” to better understand “the incubation period, case fatality ratio (the proportion of cases that die) and the serial interval (the time between symptom onset of a primary and secondary case).”
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3 February 2020
Downgrade looms as budget deficit widens
Government Finance Update: Deteriorating fiscal metrics continue to make SA susceptible to a ratings downgrade
The cumulative budget deficit for the first nine months (April to December) of the 2019/20 fiscal year totalled R249.7bn versus a deficit of R163.1bn incurred in the corresponding period of the 2018/19 fiscal year.
Revenue collections for the year to date totalled R967.0bn translating to an increase of 4.8% y/y, however this was outpaced by a 12.0% y/y growth in expenditure to R1216.8bn.
We do not anticipate total revenue amassed to reach the target put forward in the MTBPS, as it is currently only hovering at around 71.0% of the projected figure.
On the expenditure front, cumulative interest costs climbed to R127.4bn for the year to date, translating to a 10.6% y/y increase. Over the medium term (2019/20 – 2021/22) debt service costs are expected to remain the fastest growing spending category, reflecting the increase in government debt levels.
Economic growth prospects have softened further, with a lackustre GDP growth reading of below 0.5% projected for 2019. Personal income tax growth will likely be restricted by job losses, slower wage growth and an increase in immigration levels. Similarly, the subdued economic climate, exacerbated by electricity load shedding has seen numerous corporates shut downs, reducing the corporate tax pool.
Heightened financial support to cash strapped SOEs, coupled with persistent revenue shortfalls, will continue to weigh negatively on the fiscal metrics. In turn making SA vulnerable to a sovereign credit rating downgrade by Moody’s ratings agency to non-investment grade. South Africa’s rating with S&P and Fitch is already at non-investment grade.
Revenue collections for the year to date totalled R967.0bn translating to an increase of 4.8% y/y, however this was outpaced by a 12.0% y/y growth in expenditure to R1216.8bn.
We do not anticipate total revenue amassed to reach the target put forward in the MTBPS, as it is currently only hovering at around 71.0% of the projected figure.
On the expenditure front, cumulative interest costs climbed to R127.4bn for the year to date, translating to a 10.6% y/y increase. Over the medium term (2019/20 – 2021/22) debt service costs are expected to remain the fastest growing spending category, reflecting the increase in government debt levels.
Economic growth prospects have softened further, with a lackustre GDP growth reading of below 0.5% projected for 2019. Personal income tax growth will likely be restricted by job losses, slower wage growth and an increase in immigration levels. Similarly, the subdued economic climate, exacerbated by electricity load shedding has seen numerous corporates shut downs, reducing the corporate tax pool.
Heightened financial support to cash strapped SOEs, coupled with persistent revenue shortfalls, will continue to weigh negatively on the fiscal metrics. In turn making SA vulnerable to a sovereign credit rating downgrade by Moody’s ratings agency to non-investment grade. South Africa’s rating with S&P and Fitch is already at non-investment grade.
You may also be interested in the following updates in January
6 January 2020
Rand Note: Rand pierces R14.00/USD mark during festive period
The rand strengthened in the last few days of 2019, before depreciating as the US kills Iran’s top military leader. SA economic growth realities, as load shedding is reinstituted, also sour rand sentiment
The rand strengthened to R13.96/USD, R15.58/EUR and R18.27/GBP in the last few days of 2019, buoyed by the typical strengthening trajectory this time of year, until the unexpected shock of the US’s killing of General Qassem Soleimani. Resultant risk-off saw the domestic currency weaken to R14.37/USD, R16.00/EUR and R18.79/GBP.
The US ordered military strike, which resulted in the death of the Iranian General, saw Iran cancel its 2015 nuclear deal agreement, with both the US and Iran threatening very severe attacks going forward, causing tensions in other countries in the Middle East to flare, with risk of war harming sentiment in global financial markets .
Oil prices rose on fears of tightening supply as retaliatory attacks are feared on oil pipelines, shipping in the Strait of Hormuz and/or the Red Sea, as well as on cyber and American targets. The WTI (West Texas Intermediate) oil price has risen to around US$64/bbl, and the Brent crude oil price to close to US$70/bbl.
The WTI crude oil price has run closer to US$55/bbl in 2019, with a high number of US shale oil producers indicating breakeven above the US$55/bbl mark for WTI crude. Indeed, even with the WTI crude price closer to US$57/bbl in Q4.19, US drilling activity contracted, with a negative impact also on firms in related services industries.
A number of US firms in the industry were reported to be expected to cut capital expenditure this year, with weak oil prices and high costs cited, and some worries also around solvency and bankruptcy. However, this generally depressed sentiment of US shale oil producers was recorded prior to the jump in oil prices following the death of Iran’s General.
With the US-led global trade war expected to see a first phase deal signed between the US and China mid-January, the rand had been gaining fairly steadily since October to the end of 2019, before it weakness in January. Today, the rand has pulled back somewhat, to R14.22/USD, R15.92/EUR and R18.67/GBP, from its weak levels on Friday.
Rand volatility tends to be lower in the first quarter of the calendar year, as neutral to risk-on sentiment tends to prevail during the Northern Hemisphere winter as traders are typically more active, and larger risk takers than during the Northern Hemisphere summer months of vacation, resulting in some seasonality for the rand and other EM currencies.
This seasonality may be aiding a less subdued response to the US-Iran military conflict (absent further escalation). The global seasonal effects for EM currencies often see the search for yield shrug off bad news, more quickly than the more risk averse, and often thinner, trading months in the middle two quarters of the year.
Eskom’s reinstitution of load shedding likely also weakened the domestic currency in January. Indeed, Eskom warns that insufficient electricity supply could persist for two years, which is clearly negative for South Africa’s GDP growth and so for market sentiment on the rand.
The US ordered military strike, which resulted in the death of the Iranian General, saw Iran cancel its 2015 nuclear deal agreement, with both the US and Iran threatening very severe attacks going forward, causing tensions in other countries in the Middle East to flare, with risk of war harming sentiment in global financial markets .
Oil prices rose on fears of tightening supply as retaliatory attacks are feared on oil pipelines, shipping in the Strait of Hormuz and/or the Red Sea, as well as on cyber and American targets. The WTI (West Texas Intermediate) oil price has risen to around US$64/bbl, and the Brent crude oil price to close to US$70/bbl.
The WTI crude oil price has run closer to US$55/bbl in 2019, with a high number of US shale oil producers indicating breakeven above the US$55/bbl mark for WTI crude. Indeed, even with the WTI crude price closer to US$57/bbl in Q4.19, US drilling activity contracted, with a negative impact also on firms in related services industries.
A number of US firms in the industry were reported to be expected to cut capital expenditure this year, with weak oil prices and high costs cited, and some worries also around solvency and bankruptcy. However, this generally depressed sentiment of US shale oil producers was recorded prior to the jump in oil prices following the death of Iran’s General.
With the US-led global trade war expected to see a first phase deal signed between the US and China mid-January, the rand had been gaining fairly steadily since October to the end of 2019, before it weakness in January. Today, the rand has pulled back somewhat, to R14.22/USD, R15.92/EUR and R18.67/GBP, from its weak levels on Friday.
Rand volatility tends to be lower in the first quarter of the calendar year, as neutral to risk-on sentiment tends to prevail during the Northern Hemisphere winter as traders are typically more active, and larger risk takers than during the Northern Hemisphere summer months of vacation, resulting in some seasonality for the rand and other EM currencies.
This seasonality may be aiding a less subdued response to the US-Iran military conflict (absent further escalation). The global seasonal effects for EM currencies often see the search for yield shrug off bad news, more quickly than the more risk averse, and often thinner, trading months in the middle two quarters of the year.
Eskom’s reinstitution of load shedding likely also weakened the domestic currency in January. Indeed, Eskom warns that insufficient electricity supply could persist for two years, which is clearly negative for South Africa’s GDP growth and so for market sentiment on the rand.
You may also be interested in the following updates
27 August 2019
Rand outlook: Elevated risk aversion in global markets causes marked rand sell-off
The rand sell-off in what is typically a risk off period for the domestic currency. The fourth quarter of the calendar year tends, in contrast, to see the rand recover.
The rand has weakened materially this month, to R15.50/USD, R17.19/EUR and R18.81/GBP fromR13.81/USD, R15.42/EUR and R17.15/GBP earlier in the quarter. Renewed fears of global recession initially saw a material sell-off of EM currencies, reinforced by market concerns over a perceived insufficiently dovish tone from the Fed following its July FOMC meeting.
The US economy is evincing strong economic growth, running at full employment, and leading to Fed caution on the monetary easing front. The FOMC was clear that the 25bp cut in interest rates at its July meeting did not necessarily indicate the start of a lengthy interest rate cut cycle, but more recently, commentary from Jackson Hole seems less opposed to additional easing.
Rand weakness ensued in August on the back of the Fed commentary after its July meeting, alongside worsening policy uncertainty in SA, delayed growth-enhancing reforms, fears of the need for an IMF bailout and the lack of resolution to the Eskom debt crisis.
Despite the IMF subsequently denying that SA needed financial rescue, the rand failed to strengthen, dragged down most recently by further trade developments at the past weekend. The domestic currency has been running towards the down side in August, as indicated by an earlier increase in the probability of the risks to the down side already in July, leading to a revision now of the H2.19 expected case currency forecasts.
The US economy is evincing strong economic growth, running at full employment, and leading to Fed caution on the monetary easing front. The FOMC was clear that the 25bp cut in interest rates at its July meeting did not necessarily indicate the start of a lengthy interest rate cut cycle, but more recently, commentary from Jackson Hole seems less opposed to additional easing.
Rand weakness ensued in August on the back of the Fed commentary after its July meeting, alongside worsening policy uncertainty in SA, delayed growth-enhancing reforms, fears of the need for an IMF bailout and the lack of resolution to the Eskom debt crisis.
Despite the IMF subsequently denying that SA needed financial rescue, the rand failed to strengthen, dragged down most recently by further trade developments at the past weekend. The domestic currency has been running towards the down side in August, as indicated by an earlier increase in the probability of the risks to the down side already in July, leading to a revision now of the H2.19 expected case currency forecasts.
You may also be interested in the following updates in August
12 August 2019
Rand outlook: Elevated risk aversion in global markets causes marked rand sell-off
The rand sell-off in what is typically a risk off period for the domestic currency. The fourth quarter of the calendar year tends, in contrast, to see the rand recover.
The rand has seen a further marked sell-off at the start of this week, depreciating to R15.46/USD, R17.28/EUR and R18.66/GBP from R13.98/USD, R15.77/EUR and R17.59/GBP a month ago. Risk aversion in global financial markets has elevated, leading to EM currency sell-off.
Financial market players’ concerns over global economic growth have sparked the latest sell-off (see “Rand note: Rand weakens as heightened global trade tensions add to the downside”, 6th August 2019, see website address below), a sell-off exacerbated by the inherent risk aversion of the northern hemisphere summer period.
Typically global financial markets experience a sell in May-and-go-away phenomenon, namely the northern hemisphere summer vacation effect which tends to result in an exodus from riskier assets as many market players take time off, and are mostly out of the markets away on holiday.
The dovish FOMC tone in the first half of the year, and even most of July, countered most of the May-and-go-away phenomenon this year, as a series of US interest rate cuts were expected, and as such, were seen to provide protection against the weakness in global economic growth.
However, at the end of July FOMC commentary did not deliver the very dovish tone that markets were expecting, and financial markets consequently reduced expectations of further US interest rate cuts this year, cuts that were seen to be needed to stave off market concerns over economic growth (see “FOMC note”, 1st August 2019).
July’s US interest rate cut itself was deemed insufficient in the face of the risks for economic activity emanating from the escalation in trade tensions, which, combined with weak data from other key areas such as the Eurozone and China, has also exacerbated the risk-off environment.
Market players are now particularly concerned that, in the absence of further US interest rate cuts this year, aggressive US-led trade protectionism will see US, and indeed global, economic growth slow markedly, typically negative for equities, and other perceived risky assets, such as EM assets.
Financial market players’ concerns over global economic growth have sparked the latest sell-off (see “Rand note: Rand weakens as heightened global trade tensions add to the downside”, 6th August 2019, see website address below), a sell-off exacerbated by the inherent risk aversion of the northern hemisphere summer period.
Typically global financial markets experience a sell in May-and-go-away phenomenon, namely the northern hemisphere summer vacation effect which tends to result in an exodus from riskier assets as many market players take time off, and are mostly out of the markets away on holiday.
The dovish FOMC tone in the first half of the year, and even most of July, countered most of the May-and-go-away phenomenon this year, as a series of US interest rate cuts were expected, and as such, were seen to provide protection against the weakness in global economic growth.
However, at the end of July FOMC commentary did not deliver the very dovish tone that markets were expecting, and financial markets consequently reduced expectations of further US interest rate cuts this year, cuts that were seen to be needed to stave off market concerns over economic growth (see “FOMC note”, 1st August 2019).
July’s US interest rate cut itself was deemed insufficient in the face of the risks for economic activity emanating from the escalation in trade tensions, which, combined with weak data from other key areas such as the Eurozone and China, has also exacerbated the risk-off environment.
Market players are now particularly concerned that, in the absence of further US interest rate cuts this year, aggressive US-led trade protectionism will see US, and indeed global, economic growth slow markedly, typically negative for equities, and other perceived risky assets, such as EM assets.
01 August 2019
FOMC note: The US Federal Open Market Committee cuts by 25bp as expected
Rand fails to strengthen as national treasury announces an increase in bond issuance per week in SA to support Eskom bailout, Moody’s downgrade becomes more likely for South Africa.
The US Federal Open Market “Committee … (FOMC) … decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent” as expected at its July 2019 meeting. Two committee members voted against the cut, preferring that the fed funds target rate was left unchanged instead.
Specifically, the FOMC worried that “although growth of household spending has picked up from earlier in the year, growth of business fixed investment has been soft. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent.”
The FOMC in particular highlighted global growth concerns in its decision to cut interest rates, stating “in light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate.”
The rand had already priced in this 25bp US rate cut aleady in July (see “Bond note: rising expectations of a 25bp cut at the July FOMC meeting sees the rand drop through R14.00/USD, and the yield on the R186 through 8.00%, with the US yield curve maintaining inversion over the 10 year - 3 month period since May”, 11th July 2019, website address below).
Severe financial deterioration of South Africa’s electricity utility, Eskom, has added to the pressure on SA’s government finances. SA’s Finance Ministry recently detailed a special appropriation bill for an additional R59bn for Eskom over two years, which will widen the budget deficit, with National Treasury announcing additional weekly bond issuance of around 27%.
Moody’s immediately responded that SA’s “Government proposal to more than double support to Eskom is credit negative”. Moody’s is the last of the three key credit rating agencies to hold SA long-term debt on investment grade, Fitch also responded immediately, dropping SA rating outlook to negative, indicating that a credit rating downgrade is on the cards.
Specifically, the FOMC worried that “although growth of household spending has picked up from earlier in the year, growth of business fixed investment has been soft. On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent.”
The FOMC in particular highlighted global growth concerns in its decision to cut interest rates, stating “in light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate.”
The rand had already priced in this 25bp US rate cut aleady in July (see “Bond note: rising expectations of a 25bp cut at the July FOMC meeting sees the rand drop through R14.00/USD, and the yield on the R186 through 8.00%, with the US yield curve maintaining inversion over the 10 year - 3 month period since May”, 11th July 2019, website address below).
Severe financial deterioration of South Africa’s electricity utility, Eskom, has added to the pressure on SA’s government finances. SA’s Finance Ministry recently detailed a special appropriation bill for an additional R59bn for Eskom over two years, which will widen the budget deficit, with National Treasury announcing additional weekly bond issuance of around 27%.
Moody’s immediately responded that SA’s “Government proposal to more than double support to Eskom is credit negative”. Moody’s is the last of the three key credit rating agencies to hold SA long-term debt on investment grade, Fitch also responded immediately, dropping SA rating outlook to negative, indicating that a credit rating downgrade is on the cards.
You may also be interested in the following updates in July
29 July 2019
Rand note: Rand runs back through R14.00/USD
South Africa is seen to move closer to becoming a sub-investment grade country, as rated by all three of the key credit rating agencies - the probability of the lite down case increases
After reaching R13.86/USD, R15.62/EUR and R17.40/GBP last week, the rand has run back above R14.00/USD, and closer to R16.00/EUR and R18.00/GBP, as Finance Minister Mboweni proposed further support for Eskom. Fears have arisen of further tax hikes in an environment where growth has dropped towards zero in a decade of rising direct and indirect taxation.
Two credit rating agencies indicated further credit rating downgrades could be on the cards for SA, with Moody’s specifically highlighting that “the Government proposal to more than double support to Eskom is credit negative” – Moody’s is the last of the three key credit rating agencies to hold SA long-term debt on investment grade.
Prior to SA’s government comments on Eskom, the rand had convincingly strengthened past the R14.00/USD key resistance level on financial market expectations that the US will cut its interest rates this year by 50bp, with a 25bp cut expected to occur as early as this week.
However, the special appropriation bill from the Finance Ministry, detailing an additional R59bn for Eskom over two years, was met with a negative reaction from the rand as both Moody’s and Fitch signalled it increased the risk of further downgrades, with Moody’s specifying “(i)f passed, the additional support … (to Eskom)… would be an additional drain on fiscal resources.”
In particular, Moody’s worries that “South Africa's sluggish growth outlook limits its ability to absorb the extra cost of Eskom support”, and that “(n)o clear strategic turnaround plan agreeable to all stakeholders has emerged yet, fuelling risks for the government of having to provide additional support”.
We have revised our probability of the lite down case to 35% from 25% as the likelihood of SA receiving a credit rating downgrade from Moody’s is increasing, with the probability of the expected case falling to 45% from 50%, and that of the severe down case falling to 9% from 14% as the FOMC becomes increasingly dovish, and global growth risks reduce.
Two credit rating agencies indicated further credit rating downgrades could be on the cards for SA, with Moody’s specifically highlighting that “the Government proposal to more than double support to Eskom is credit negative” – Moody’s is the last of the three key credit rating agencies to hold SA long-term debt on investment grade.
Prior to SA’s government comments on Eskom, the rand had convincingly strengthened past the R14.00/USD key resistance level on financial market expectations that the US will cut its interest rates this year by 50bp, with a 25bp cut expected to occur as early as this week.
However, the special appropriation bill from the Finance Ministry, detailing an additional R59bn for Eskom over two years, was met with a negative reaction from the rand as both Moody’s and Fitch signalled it increased the risk of further downgrades, with Moody’s specifying “(i)f passed, the additional support … (to Eskom)… would be an additional drain on fiscal resources.”
In particular, Moody’s worries that “South Africa's sluggish growth outlook limits its ability to absorb the extra cost of Eskom support”, and that “(n)o clear strategic turnaround plan agreeable to all stakeholders has emerged yet, fuelling risks for the government of having to provide additional support”.
We have revised our probability of the lite down case to 35% from 25% as the likelihood of SA receiving a credit rating downgrade from Moody’s is increasing, with the probability of the expected case falling to 45% from 50%, and that of the severe down case falling to 9% from 14% as the FOMC becomes increasingly dovish, and global growth risks reduce.
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