There has been increasing
speculation in the market as to
when China will relax the pegging
of the Chinese Yuan to the US Dollar.
China is facing increasing pressure,
not only from the United States
but also from various Asian countries
and parts of the European Union,
to do so. Beijing, however, say
that they will not be rushed. According
to a recent report by the US Treasury
Department "while China's 10 year
long pegged currency regime may
have at times contributed to stability,
it no longer does."
In 2004 China grew by more than
9% for a second year in a row. Contributing
largely to this growth were exports,
resulting in China's trade surplus
reaching six year highs. This is
certainly not good news for countries
like the United States and Japan.
The American trade deficit with
China increased to $162bn in 2004,
up from $124bn in 2003. The United
States claims that the Yuan is undervalued
and that this is giving Chinese
export companies an unfair advantage.
If the Yuan is indeed artificially
depressed, China is able to export
goods more cheaply. This also gives
goods exported from China a price
advantage over many goods produced
domestically in foreign countries,
pricing a lot of these domestic
goods out of the market. Some have
gone as far as to speculate that
the Yuan may be up to 40% undervalued.
Consequently, many Americans blame
China for a lot of the job losses
in the US.
According to a recent statement
issued by John Snow, the US Treasury
Secretary, the Yuan's fixed rate
of exchange against the dollar risks
unbalancing world trade. Later this
year, the US Senate is to vote on
a bill "which would impose a 27.50%
tariff on all Chinese imports to
the United States unless China removes
the currency peg within six months."
According to Snow, "China must also
play its part in promoting sustained
world economic growth and the adjustment
to international imbalances. This
is where China's exchange rate is
key."
And of course, South Africa, too,
is badly affected by cheap imports
from China. More specifically, our
domestic clothing industry, which
is reported to have lost more than
4 000 jobs since January (when global
trade quotas on textiles were removed).
Trade unionists estimate that some
17 000 jobs were lost last year
in our domestic clothing industry
alone. Gert van Zyl, executive director
of the Cape Clothing Industry stated
recently "we are considering whether
to apply to the World Trade Organisation
in an attempt to put safeguard measures
in place."
The consequences of the Yuan remaining
firmly pegged to the US Dollar going
forward are far reaching. It appears
as if the Chinese authorities can
no longer afford to ignore the increasing
pressure being brought on them by
the rest of the world to bring about
currency reform. Will they do it?
Probably, but only when they deem
it necessary. Only time will tell.
The "Feds" fund rate, which increased
to 3% in May (the eighth increase
since June last year), is now at
its highest level since September
2001. In their statement following
on from the most recent rate increase,
the Federal Reserve stated that
"recent data suggests that the solid
pace of spending growth has slowed
somewhat, partly in response to
the earlier increases in energy
prices." GDP growth, which slowed
during the first quarter of 2005,
came in below expectations, at 3.1%.
Higher oil prices have largely been
blamed for this reduced number.
The Federal Reserve are keeping
a close watch on inflation. In March,
CPI recorded its highest gain since
October last year - rising by 0,60%.
The CPI figure (which includes both
food and energy costs) annualised
for the first three months of this
year, was 4,3% - which is one percent
higher than the CPI figure recorded
for 2004.
Based on these figures, concerns
have been raised about whether interest
rates will continue to increase
at a "measured" pace or whether
sharper increases will be required.
Commenting on the most recent CPI
numbers, Robert Macintosh an economist
for Eaton Vance Management, stated
"you can't make a decision on an
individual number but just based
on this one number, this would make
the Fed more emboldened perhaps
to continue tightening."
The lower than expected first quarter
GDP data, pedestrian first quarter
earnings and retail sales, together
with a concern about rising inflation,
are some of the conflicting trends
that have started to raise concerns
about the possible onset of stagflation,
which typically is a combination
of rising prices and sluggish growth.
With growth having remaining sluggish
during 2005, it is hoped that the
Federal Reserve will not need to
raise rates significantly higher
(or at a faster pace) as this could
have a negative impact on growth.
May marked the two year anniversary
of rates having been kept on hold
at 2% in the Eurozone. This is despite
rates having increased from 1% to
3% in the United States and from
3.50% to 4.75% in the United Kingdom,
over the same period.
It is interesting to note the rate
movements in the different regions.
Seven changes have been made to
rates by the ECB since the beginning
of 2001. From May 2001 rates declined
sharply from 4,50% to 2% in June
2003. Over the same period, the
Federal Reserve in the United States
made 21 changes to interest rates
- first by cutting rates from 6%
(in January 2001) to 1% (in June
2003) and then by tightening rates,
from June 2004. The Bank of England
made 16 changes to interest rates
over this period, reducing rates
from 6% to just 3.5%, before starting
to increase rates in November 2003
(currently at 4.75%).
Inflation remains slightly above
the 2% target level, largely due
to the sustained high oil price.
Some economists have indicated,
however, that they "see the possibility
of a cut in rates later in 2005".
This view may be as a result of
the pedestrian growth numbers for
the region. However, the rising
oil price and the risk that this
is likely to pose to an increase
in prices (and, of course, to inflation)
would ordinarily imply an increase
in interest rates. These risks have
been evident for some time, with
no change in mandate by the ECB.
According to ECB President, Jean-Claude
Trichet, "there is no contradiction
at all between being faithful to
our mandate and preserving an environment
as favourable as possible for growth
and job creation."
Interest rates, which last changed
in August 2004, remained at 4.75%
for the period under review. This
was largely expected in light of
the slowdown in consumer spending
and inflation remaining contained.
David Frost, Director General of
the British Chamber of Commerce
said recently "we strongly urge
the MPC to persevere with a cautious
stance and keep interest rates on
hold for the next few months." There
are inconsistent views as to whether
interest rates have now peaked,
or whether there is still scope
for further increases.
According to Marchel Alexandrovich,
an analyst at Dresdner Kleinwort
Wasserstein, "our view remains that
a continued housing market slowdown
and its adverse impact on consumer
spending means that rates have already
peaked and will start heading down
later this year." Andrew Large (deputy
governor) and Paul Tucker (executive
director), the two MPC members who
voted for a rate rise last month,
believe that "the consumer slowdown
was temporary."
However, the National Institute
of Economic and Social Research
stated recently that "without a
rise [in interest rates] it may
be hard to keep inflation below
the 2% target." They have forecast
that the economy "will grow by 2.7%
in 2005, rather than the 3% to 3.5%
predicted by Chancellor Gordon Brown."
Gross domestic product slowed to
0.60% for the first quarter of 2005,
compared to 0.70% during the last
quarter of 2004. A slowdown in industry
inputs and in consumer spending
are being cited as the main reasons
for the drop in GDP growth.
Despite conflicting reports, it
appears as if the housing market
is "cooling". The Nationwide survey
in March reported the biggest monthly
drop in prices in 10 years, whereas
Halifax stated that housing prices
had risen by 0,50% during this month.
In April, however, Nationwide reported
that house prices reversed the 0.60%
decline in March and rose by 0.90%.
Describing the overall trend as
"broadly flat" they reported that
the annual rate of property price
inflation had declined from 7.90%
to 7%. "The trend continues to confirm
our view of a gentle slowing of
the market."
According to Capital Economics "buyers
are no longer willing or able to
meet asking prices and sellers are
reluctant to lower their expectations."
It appears as if home owners are
battling to cope with the latest
round of interest rate increases
as the Department of Constitutional
Affairs have stated that "the number
of property repossession orders
rose by 25% in the first three months
of 2005, against the same period
in 2004."
On the 6th May, Tony Blair won his
third term in government for the
Labour Party. Despite Mr Blair being
the only Labour Party leader to
win three elections in a row, the
margin of this victory was far less
than those achieved in 1997 and
2001.
Mixed signals continue to emerge
from this region. The Shoko Chukin
Survey (which measures small business
sentiment) and the sentiment of
large manufacturers showed a modest
decline, while the Tankan Survey
(which is the most closely watched
of all the indicators in Japan)
showed that "business confidence
in the non-manufacturing sector
was unchanged at 11, the highest
level ever recorded except during
the asset price bubble in the late
1980's." The manufacturing sector
remains robust, with the strongest
areas being industrial machinery,
auto and materials. A cyclical slowdown,
however, would impact negatively
as these particular areas in manufacturing
are sensitive to movements in the
global economy. Other areas showing
an improvement include retail sales
and the residential property market.
"Real estate prices in Tokyo are
rising for the first time in years."
As in all the regions, the high
oil price has impacted negatively
on growth. It is expected that the
Japanese economy will grow by 1%
in 2005.
In April the Reserve Bank reduced
the Repo rate by 50 basis points
(0.50%), reducing the Repo rate
to 7% and the prime lending rate
to 10.50%. This move, which was
unexpected by the markets, caused
the Rand to depreciate by 2% within
minutes of the announcement. The
interest rate cut appears to have
been motivated by three factors
- "firstly, the fact that inflation
is extremely low and that inflation
expectations have fallen further.
Secondly, some evidence of softness
in the economy, particularly the
manufacturing sector. Thirdly, the
need for South Africa to have a
more competitive exchange rate."
There are conflicting views on how
this rate cut could impact on the
currency in the weeks ahead - the
first is that "the rate cut could
result in further Rand weakening
as interest rate differentials between
South Africa and developed markets
narrow, reducing the implied risk
premium. Alternatively, strong growth
in the local economy, fuelled by
the cut, could attract large capital
flows, which would help fund the
widening current account deficit."
When announcing the rate cut, the
Reserve Bank highlighted a number
of positive issues for inflation.
They are of the opinion that the
current forecast for inflation still
looks encouraging. Because of the
sustained low level of PPI (producer
price inflation), they do not expect
significant upward pressure on consumer
prices in the short term. The expect
CPI to peak at about 5.25% early
next year and to then decline towards
the middle end of the targeted band
(between 3% and 6%).
Once again, however, they highlighted
the current risks to their inflation
outlook. These include "the uncertainty
relating to international oil prices,
domestic expenditure continues to
be robust, strong growth in money
supply and credit extension by the
banking sector, the widening deficit
on the current account of the balance
of payments, the prospects for the
international economy have become
more uncertain and the IMF and the
World Bank have revised down their
forecast for growth in 2005, particularly
in the Eurozone and Japan."
The oil price spiked during the
quarter under review, but ended
the quarter at $50.23 per barrel,
compared to $50.14 at the end of
February. The spikes in the price
were fuelled mainly by supply and
demand issues as well as by concerns
relating to refinery problems in
the United States. In their twice
yearly report on global economic
prospects, the International Monetary
Fund warned of the increasing threat
that rising oil prices pose to global
economic growth. They reported that
"the strength of the demand for
oil from China and India had caught
the international community by surprise."
Year to date, our domestic petrol
price has increased by more than
25%.
The gold price declined further,
ending the quarter at $416.65 an
ounce compared to a close of $435.85
at the end of February. It is interesting
to note that last year, the South
African gold mining industry recorded
its lowest level of production since
1931, largely as a result of the
strong Rand and increasingly high
costs.
The Rand weakened to 7 month lows
during May fuelled by a stronger
US Dollar, calls from the ANC for
a more "competitive" exchange rate
and the news that Cosatu are set
to strike in June "to protest currency-related
job losses". The Finance Minister,
however, has "raised serious concern
about adopting an official policy
to defend a particular level of
the Rand exchange rate" the Business
Day reported recently.
Domestic resources, a sector very
much out of favour last year, returned
17.50% in the first quarter of 2005,
while both financials and industrials
were only marginally positive. This
"bounce back" in resources was aided
by the combination of a weaker Rand
and firmer commodity prices. The
surprise interest rate cut in April,
though, favoured the industrial
and financial sectors. The turbulent
equity environment continues to
make it difficult for domestic fund
managers this year. While we believe
that the risk premium for domestic
equities has risen since our last
report, we continue to believe that
equities will be the asset class
of choice in the domestic market
this year. As stated in our last
report, it appears as if the "easy"
money has been made in this equity
cycle.
QUARTERLY QUOTE
"In the business world, the rearview
mirror is always clearer than the
windshield"
Warren Buffett
This report is based on information
sourced from various institutions,
both local and international. The
report reflects a variety of views
and is not intended to convey investment
advice. Please consult us to obtain
specific advice relevant to your
investment portfolio.
