Global equity markets rebounded strongly in June, recovering most of the losses endured in May. Although most economic data released in the month continued to point to slightly slower growth, dovish rhetoric from major central banks boosted risky assets. Markets are currently pricing in a fair number of interest rate cuts by the Federal Reserve (Fed) over the next 12 months. The lower interest rate outlook has reignited the search for yield and more than $13 trillion of global issued bonds are now trading under zero percent.
In the United States (US), most indicators confirmed our view that growth is decelerating closer towards trend. The IHS Markit Manufacturing Purchasing Managers’ Index (PMI) fell to 50.1 in June from 50.5 in May and below market expectations of 50.4. The US new home sales also fell more than expected in May; sales dropped 7.8% to a seasonally adjusted annual rate of 626 000, against expectations of a 1.9% increase. The US government budget deficit widened sharply to $208 billion in May from $147 billion in the same month last year. Expectations were for a fall to $186 billion. On the positive side US industrial output rose 0.4% in May, beating expectations of a 0.2% gain and reversing the 0.4% fall from the previous month. Retail sales rose 0.5% in May from upwardly revised 0.3% growth in April. Core Personal Consumption Expenditure (PCE) inflation came out at 1.6% year-on-year, as expected. The Fed held rates steady at 2.25% - 2.5% and left their growth forecasts for 2019 unchanged. The Fed did, however, drop a promise to be “patient” in adjusting rates and said that it will act as appropriate to sustain the economic expansion.
Data from the Eurozone was mixed. The annual inflation rate fell to 1.2% in May from 1.7% in April. This is the lowest inflation rate since April of last year. The biggest contributors to the slowdown were lower energy and services costs. Core inflation, which excludes volatile prices of energy and food, slowed to 0.8% in May from 1.3% in April. The European Central Bank held its benchmark rate at zero percent during its June meeting, but concerns about the global growth and inflation outlook tilted guidance to the dovish side. A first-rate hike was pushed out to the second half of next year at the earliest. Manufacturing PMI came in at 47.8 in June from 47.7 in May, the fifth straight month of contraction. Services PMI surprised to the positive side, coming out at 53.4 in June from 52.9 in May.
In the United Kingdom (UK), the race is on between Boris Johnson and Jeremy Hunt in who will become the next Prime Minister. With this, the odds of a no-deal Brexit have increased. Inflation came down to 2.0% in May from a four-month high of 2.1% in April, in line with expectations. Manufacturing PMI fell to 49.4 in May from 53.1 in April, well below market expectations of 52. Services PMI rose to 51 in May from 50.4 in April, beating expectations of 50.6. The Bank of England’s Monetary Policy Committee voted unanimously to hold the Bank Rate at 0.75% during its June meeting and reaffirmed its pledge to gradual rate increases over the forecast period, despite ongoing Brexit concerns and global trade tensions.
In China, consumer price inflation rose to 2.7% in May from 2.5% in April. This was the highest inflation print since February 2018, as food costs increased on the back of the outbreak of African swine fever that caused pork prices to spike. Notwithstanding trade wars, the trade surplus soared to $41.66 billion in May from $23.42 billion in the same month a year earlier. This was the largest trade surplus since December 2018, as exports rose unexpectedly while imports dropped the most in nearly three years. The Caixin General Manufacturing PMI was unchanged at 50.2 in May, slightly above market expectations of 50. On the other side Services PMI dropped to 52.7 in May from 54.5 in April, missing market expectations of 54.3.
Japanese consumer price inflation fell to 0.7% year-on-year in May from a six-month high of 0.9% in April and in line with expectations. The slowdown was mainly led by electricity, transport and housing. Meanwhile, prices of food rose for a second straight month. Looming tax hikes are a threat to future household consumption.
On the local front, inflation rose to 4.5% in May from 4.4% in April, slightly above market expectations of 4.4%, but still well within the Reserve Bank’s target rate of 3% - 6%. Main upward pressure came from housing, utilities and food, while transport slowed.
The trade deficit came out at R3.43 billion compared to a downwardly revised R4.7 billion surplus in the previous month. Exports fell 1.3% while imports soared 6.8%.
The RMB/BER Business Confidence Index stood at 28 in the second quarter of 2019, unchanged from the previous period. Sentiment deteriorated among new vehicle dealers and manufacturers, but some improvements were seen in building, retail and the wholesale trade sectors. The State of the Nation Address (SONA) did not do much to inspire markets and went by mostly unnoticed, lacking detail, except for highlighting the urgent need for capital assistance to Eskom.
From a market perspective the bond yield curve steepened to new highs. The front-end of the curve rallied on the back of major central banks indicating that cuts could be on the way, whereas longer-dated bonds reacted negatively to fears of a potential higher fiscal deficit caused by a revenue undershoot and more fiscal support to the state-owned enterprises (SOEs) (mainly Eskom). The Johannesburg Stock Exchange (JSE) had a good month in sympathy with global markets as potential interest rate cuts could cushion the slowdown in global activity.
The pace of the global growth deceleration is starting to ease. Global growth for the first quarter of this year should come in quite soft. In the US, growth will slow in the face of fiscal headwinds with the gap between the US and the rest of the world expected to start narrowing. Inflation remains well contained globally and central banks have become more dovish in their rhetoric. The Fed fund rate is expected to be cut by 0.5% over the forecast horizon, although the market is pricing in the probability of more cuts. Trade war risks remain, but increased tariffs are likely to be accompanied by greater Chinese stimulus. Bond yield forecasts are higher than spot rates across the board. The trade-weighted dollar is expected to weaken, although short-term strength remains a risk. Global equities have more investment merit than global bonds based on elevated earnings yield versus bond yields.
Locally, evidence of reform will be necessary to boost policy confidence and yield higher private sector investment. Economic growth will likely be constrained to below 2% until then. While we anticipate better than money market returns from growth assets over the next 12 months, mostly on valuation grounds, muted business confidence remains a significant impediment. An improvement in confidence would be required to generate returns in the double-digit range. Other near-term constraints include tight fiscal conditions and challenges to the national electricity supply.