Weekly Economic Focus: Brexit, Italy, Japan and China all have a problem of some sort

By Alexander Forbes Investments on Nov 19, 2018 in Economic Insights


Global wrap –  Brexit, Italy, Japan and China all have a problem of some sort

  • The UK and EU reached agreement on the draft Brexit agreement and the UK Cabinet backed it, but several resignations and a vote of no confidence in Prime Minister May threatened to collapse her government.
  • Italy defied the European Commission by submitting a budget that shows no consolidation.
  • Trade tensions are starting to bite as Germany and Japan’s economic growth contracts, while China’s activity indicators moderate.
  • Surveys show that US banks will increase borrowing costs if the US yield curve inverts, indicating that a rising US interest rate will impact economic growth sooner or later.
  • In emerging markets, the Philippines and Indonesia raised rates for the fifth and sixth consecutive time to 4.75% and 6.0%, respectively, but this will not pressure the SARB to hike yet, as oil prices declined by 17.5% over the past month as OPEC revises its oil production forecasts.
  • A slightly stronger rand and a decrease in oil prices point to a R1.54 petrol price cut in December, which will improve the CPI inflation outlook, meaning the SARB is not under pressure to hike rates yet.
  • South Africa’s technical recession will come to an end in Q3 2018 as quarterly growth in retail sales, wholesale sales and manufacturing production offset the contraction in mining production.

US – Strong headline CPI and moderating core inflation suggests gradual rate-hiking path

US equities fell last week, with the NASDAQ and S&P 500 tumbling 3.7% and 2.7%, respectively, as the Brexit news flow from the UK permeated through the markets. Meanwhile, US Commerce Secretary Wilbur Ross is reported to have said that the US still plans to raise tariffs on Chinese imports to 25% in January, with US President Donald Trump and China’s Xi Jinping likely to agree to a framework for further talks to resolve trade tensions at an upcoming meeting.

On the data front, the decline in US core inflation to 2.1% in October, from 2.2% in September, suggests that underlying inflation is moderating, which is consistent with a gradual US Federal Reserve (Fed) rate-hiking path. Nevertheless, headline CPI edged up to 2.5% from 2.3%. On the growth front, the median estimate for Q4 2018 growth points to 2.9% quarter-on-quarter (seasonally adjusted and annualised) GDP growth, which is still robust.


Europe and the UK – Brexit progresses with hiccups and Italy’s defiance

It has been a busy week in global markets with some progress in Brexit negotiations following the UK and the European Union agreeing on the draft text of the divorce proceedings last Wednesday. This effectively put the ball in the court of UK Prime Minister Theresa May’s Cabinet, parliament and the country. On Thursday, May’s Cabinet backed the draft agreement. However, there were at least six resignations of British Conservative members of parliament in protest of the draft withdrawal agreement.


After two years of difficult negotiations, progress was made, but the road ahead remains long and difficult with a divided Cabinet, parliament and country. More pressure remains as prominent Brexit supporters are pushing for a vote of no confidence in May. The next step is parliamentary approval, with the key vote likely to take place in early December. It is difficult to call the outcome at this stage, given that Cabinet approval was through a narrow majority of six members of parliament. 

UK equities and the pound were down across the board on speculation that May’s government may collapse. The market now tracks the possibility of May’s survival, and if she does, the parliamentary ratification process, which at this point remains unclear.  

The medium-term implications for a good Brexit process will be a rise in economic growth and a stronger GBP, which will be negative for UK equities, given that only about 30% of their revenues are derived from within the UK. On the contrary, a protracted Brexit process will lead to increased uncertainty, which will drag economic growth lower and the GBP weaker, but with an unclear impact on UK equities.

Italy’s budget resubmission to the European Commission is unlikely to be approved, which will result in greater oversight of Italy’s budget and the possibility of sanctions. Meanwhile, Germany’s economic growth contracted in Q3 2018, the first time since 2015, as auto exports, its traditional growth engine, was impacted by the trade disputes with the US.  In Asia, Japan’s economic growth also contracted, while evidence of slowdown has shown up in China. Looking at these developments holistically, the contraction in Germany and Japan’s growth rates and the moderation in China’s economic activity all have a common root, the trade tensions with the US, which mean that more pain from trade tensions will likely come in 2019. The growth rates are likely to rise faster than expected, if Brexit negotiations conclude smoothly and along the expected timelines.


Emerging markets – sell-off continues

The Philippines and Indonesia raised rates for the fifth and sixth consecutive time to 4.75% and 6.0%, respectively, which points to increasing pressure on emerging market countries whose currencies have weakened to increase interest rates. The MSCI Emerging Market Index rose 0.5% last week, reflecting a better performance in China. Most other emerging market equity markets declined due to risk aversion on the back of Brexit news flow.


South Africa – petrol price cut in December, lower oil prices will be enough to keep rates on hold

Of interest locally are developments in oil markets, which so far indicate that we will likely see an early Christmas gift in the form of a R1.50 cut in petrol prices in December if the rand and oil price remain relatively unchanged. The biggest contributor to this is the oil price, which is down about 18% in the past month. The rand strength against the US dollar contributes about 12 cents to the potential petrol price cut. This will likely lead to an improvement in CPI inflation outlook, of which the October print is expected to slightly edge up to 5.0% year-on-year.

Given these expectations, we expect the South African Reserve Bank Monetary Policy Committee to keep the repo rate unchanged at 6.5% at its next meeting. However, the Forward Rate Agreement market still prices in a 60% probability of a 25bp hike on 22 November.

On the economic front, we project that South Africa’s technical recession will come to an end in Q3 2018 as quarterly growth in retail sales, wholesale sales and manufacturing production offset the contraction in mining production. Growth will likely print at 1.5% quarter-on-quarter, seasonally adjusted, following a 0.7% and 2.6% contractions in Q2 2018 and Q1 2018. South Africa seems to be trading places with the global economy, as we have good news for South Africa, but not such good news in global markets. 

This weeks’ calendar is littered with the release of second tier data, thus we expect Brexit, Italy and the US-China trade talks to grab the market’s attention.

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brexit table

Alexander Forbes Investments

Alexander Forbes Investments

Alexander Forbes Investments was established in 1997. We are a forward-thinking and trusted global investment provider, with roots in Africa. In pursuit of certainty we set out to understand our retail and institutional clients’ circumstances and risk tolerance to set clear goals. Our adaptive investment approach, called Living*Investing allows us to maximise opportunity and minimise risk at every stage of the investment cycle.

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