Economic Thoughts: Intensifying Twisters

Tornados are also known as “twisters”, swirling winds capable of reaching hurricane strength and where they touch ground destroying mostly everything in their direct path.


Looking inwards & outwards, both our internal SA situation & the global picture show what increasingly look like various tornados in progress, some of these even dangerously coalescing, reinforcing (feeding) each other.


Where is all this leading? Deeper upheaval in 2016 than so far foreseen?


South Africa, like Brazil, is encountering internal dynamics that are growth destructive. In the case of Brazil already deep into recession (and having arrived at bond junk status), in the case of SA flirting on the precipice of a deeper abyss, so far skirting its edges, but apparently not realising how close to a deeper shift.


In our case, macro policy isn’t our main problem. Our fiscal finances are still holding up, through August just ahead of budget, primarily because government spending has been undershooting slightly more than tax revenue. The SARB is patrolling ever so vigilantly, protecting its monetary policy credibility, and so far keeping inflation expectations well anchored in mid-single digit (possibly the single most remarkable macro achievement of the past decade, given runaway administered prices, labour union demands, Rand weakness).


Our internal problem is a failing infrastructure, with electricity output through August steadily spiraling downward (now approaching 2009 recession lows, something not generally appreciated?). Business confidence has been trundling sideways for five years, but at half-mast levels throughout, in 3Q2015 falling to its lowest level since 2011 (only 38% of survey respondents, a mere 4-out-of-10, expressing confidence), with business managers now nearly totally devoid of political confidence (85% quoting our politics as constraining business). A SARB leading indicator has been likewise moving sideways for years, but of late with a steepening downward slant.


With many clashing micro policy & political paradigms, business doesn’t have confidence in prospects, and is far more inclined to defensive withdrawal & external diversification. Our failing public sector doesn’t support the economy as it should. This is made worse by deepening global strains offering us intensifying headwinds.


These external headwinds should not be underestimated. Struggling net trade volumes. Falling terms-of-trade (export prices falling faster than import prices). Strained capital flows (relentlessly pummeling the Rand, pushing it into deeply undervalued territory, near 14:$ rather than 10:$).


Is worse on the way? Domestically by choice (hardening political paradigms, like hardening arteries, inviting their own logic?). Externally by fate (wrong place, wrong time, no armour plating?).


I would summarize the world in October 2015 in the grip of intensifying twisters.


China is steadily progressing with its structural transformation. This means heavy industry, infrastructure & exports standing back, reducing their share of GDP, even as household consumption and services keep advancing, intend on increasing their share of GDP. A process of years, under way since 2010, steadily advancing.


The implications worldwide are deeper hits to trade, with commodity producer recessions still deepening, and many manufacturing nations skirting on the edge of recession. As much developed Japan, as other Asian regionals such as Taiwan & Singapore.


Thus the many modern Chinese dependents around the world are also having to make a structural U-turn in her wake, in their case often deeply amplified by a terrible lack of diversification. Aussie & Canada are all about commodity export, most of it to China, worsened by oil exposure. Brazil has a similar profile. Japan & many EMs have specialised their manufacturing, becoming part of many Chinese value chains, now apparently taking a step back.


Happy development assists on the way up. Terribly dislocating disrupters as it unwinds, with China moving on.


In contrast to the transforming Chinese growth story leaving so much debris in its wake, the American growth story these past six years has been modestly sedate, ever so steadily recuperating from deep wounds.


No wild undershooting, no wild escalation, just this thoroughly boring pace of digging itself out of the hole created by the Great Recession of 2008-09 and its financial crisis instigator, gradually whittling down imbalances, in housing, labour (unemployed, discouraged, underutilized), banking, construction.


The disappointing September 2015 non-farm payroll last week (only +142 000 and -59 000 revisions to previous months) does not deflect from this impression, merely reinforces it. Steady but unexciting, and not ready to lead the world out of anything (though Mexico in pole position to benefit greatly from trade proximity, ready to overtake Canada as America’s main foreign supplier, when it happens a mayor milestone).


This American picture has a sunny & dark side to it. Sunny, in that the Fed is unlikely to become aggressive soon in its policy normalisation drive, thereby not piling on the global pressures. Yet this very ambivalent nature of US recovery unnerving many, contributing to financial volatility, with many asking where US policy support will be coming from (not from fiscal & the Fed still at zero rates, with a $4.5 trill balance sheet in tow).


America is on balance not supporting the global economy in its hour of Chinese need. Her growth & trade push are too weak, her finances threatening enough to be disturbing. Strange mixture. And could it get worse?


With China firmly in transition, Japan succumbing to China trade weakness (and own internal strains), many commodity producers & Asian EMs in recession (or on its brink), and America a disturbance of bewildering complexity (and not only thinking Trump), there is still Europe to consider.


Europe was supposedly of late a simple understatement. Laid low by the Anglo-Saxon banking crisis, tripped by its own peripherals, bend on austerity, and its central bank having to fight for additional policy instruments, with the Russian trade implosion not helping, Europe was a slow growth job artificially assisted (late in the day) by ECB liquidity aggression, engineered wealth effects & a 30% Euro depreciation.


Sounds so very Japanese in too many respects.


To this has now been added a Chinese trade hit, a VW implosion, and yet more strain at the European level as the massing refugee challenge injects ever greater venom into the body politic, as much inside Germany, as on the East-West axis, with increasing numbers of people, officials & politicians not wanting to be told what to do. This closely following on from the intense North-South strains of recent years when peripherals were forced to painfully adjust.


The European Ideal is increasingly under assault from forces that seemingly want to tear it apart, limb from limb. The geopoliticals with Russia have become a lot more complex, the refugees offer social challenges, the Germans throw their growing weight around, and their European compatriots increasingly question directives so forthcoming.


How to link all this to European economic prospects? Darkening weather, with core inflation not wanting to lift (from 0.9%), and growth possibly falling back to 1% (as Japan has fallen back to zero).


This will probably incite the ECB (in December?) to announce an extension of its bond buying (beyond September 2016) at a time that the Fed may (again) delay liftoff (this time to March 2016, unless the next two non-farm payrolls show unexpected vigour?). Markets discount a probability of less than 40% of Fed December liftoff.


That makes capital flow prospects more complicated, with long bond yields (& spreads?) heading lower again, and currencies not really knowing where to go in the presence of such policy standoffs.


The Fed & ECB actions (and any Chinese support actions) may assist Emerging Market & commodity producer space, in the short term, but possibly not if financial uncertainty were to grow once Fed liftoff comes back into focus. That makes for an uncertain commodity price & Rand prospect.


Which way will this cat eventually jump? Yet more financial market turbulence to reinforce the trade pressures out of China & the structural governance strains out of Europe?


Adding our own internal strains to this growing external complexity presents a worrying picture. Can we assume business as usual, and financial market overshooting as a wonderful buy opportunity? Or are things a lot more complex, and this decade not quite finished showing us all her many “twisters”?


Cees Bruggemans, Consulting Economist
Avior Capital Markets (Pty) Ltd
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