FERRIER INTERNATIONAL keeping you updated and thank Cess Bruggemans ; Chief Economist FNB for this article.
By Cees Bruggemans, Chief Economist FNB
|09 June 2008|
We are currently in the grip of a huge global contagion, brought about by rising oil and food prices. It has taken CPIX inflation from 3.5% two years ago to 10.4% today, with the peak (also allowing for Eskom and secondary forces) likely to crest 12% in coming months.
But oil and food aren’t the only potential sources of contagion. In 2001, our monetary disturbance came aboard mainly via a spectacularly freefalling
A memorial run on the
This time we have not primarily been sandbagged by the
But there is nothing ordained or exclusive about the sequencing of such events. There is a nightmare scenario out there, at least for indebted households (and quite the contrary for export-based producers) in which another
Just as you think things couldn’t possibly get worse, with oil and food price disturbances finally topping out, triggering hopes of an unwinding of the bulging inflation shock, one could get hit by a second bus, potentially just as virulently fatal as the first.
Internationally, there are certainly those analysts who hope that both oil and food prices are in peaking territory, raising hopes of an imminent inflation cresting and unwinding later this year, eventually followed next year by a partial undoing of monetary tightening, at least in those emerging countries that have led the tightening parade this year.
Falling inflation next year certainly would invite a partial unwinding of the interest rate increases of the past two years, giving renewed hope and impetus to asset markets and reducing the growth sacrifice currently underway.
But don’t get your hopes up just yet. As the past week has shown, global conditions don’t warrant such optimism.
Mere ECB speculation of imminently higher interest rates, and further US payroll declines and especially higher unemployment at 5.5% hinting at the absence of Fed rate increases this year, gave new impetus to the Dollar weakness scenario.
This remarkable combination of events resulted in a kneejerk reversal of oil market positions, taking the price towards $140 all-time highs. And heavy rains in US maize-producing regions, along with late plantings, also pushed maize prices to record highs.
Besides such financial and weather-related reasoning, there remain many analysts overseas who don’t think the oil and food fundamentals have been turned decisively yet, making for sustained price declines soon.
Instead, such analysts keep finding reasons for further trend gains in oil and food prices. For them, our inflation nightmare continues to have legs, having further to go before finally flaming out at levels well above today’s levels.
It would, however, be most inconvenient if there would be a second contagion making its appearance before the first one has been well and truly seen off.
For such an occurrence could spell double trouble, giving another major upward twist to inflation and interest rates, superimposing new upward momentum on top of the inflation bulge currently shaping.
The only really serious candidate for such an unwelcome surprise shortly would be another major
Indeed the most powerful combination would be a 1985-2001 type of event. For there could potentially be various levels of intensity to any Rand fall, akin to measuring earthquakes (Richer Scale) or hurricanes (Beaufort Scale). A hurricane with force 5 winds is the most powerful reading possible.
What combination of events could trigger such a phenomenon?
Unlike 1985 or 2001,
Instead, like in 2001, the
Unlike 2001, but far more reminding of 1985,
But moments can occur when markets suddenly consider such deficits and their external funding needs with radically changed eyes. If events occur reminding markets of the deeper risks they are running in a country with such external deficits a failure of nerve can quite easily occur, often triggered in tandem with a wider change in perceptions (contagion).
Besides the toxic current account deficit, we are in the process of reducing our attractiveness to foreigners in two more fundamental ways.
In an effort to maintain price stability at a time of external oil and food price shocks, we are seemingly prepared to incur considerable growth sacrifice as we raise interest rates.
That tactic, however, is to be compared with an aircraft pilot throttling back speed. At some crucial point, such a move may take him below stalling speed, after which the aircraft can spiral out of control.
Uneasy financial markets are getting a little nervy on this score. How close are we getting to stalling speed, and should we panic early rather than late? This is clearly a warning sign that too much economic weakness could beget yet more penalty as withdrawing capital puts downward pressure on the
The other potential domestic source of unease is our political overlay. Will economic policies be changed, for the good or for worse? If the latter, more risk premiums may be demanded, potentially well in excess of what the Trahar/Mbeki exchange of some years back implied.
The more wrong signals we choose to send out to the world, the more unnerved markets could become, at some point potentially sandbagging the
All these features are our own doing mostly, potentially weakening our attractiveness. If in such a condition we were to encounter another vigorous external shock, the fat could once again be in the fire.
And potentially there are international areas of weakness that could trigger wider contagion as markets reconsider the appropriateness of their risk premiums across classes of financial assets.
Another source of risk would be abrupt weakness occurring in the Asian economies, this time focused on
But there are today exposed minor parts of the emerging universe that could suddenly be subjected to risk re-evaluation. In the process, re-assessment could spread wider in the asset class, drawing attention to unrelated areas showing similar features.
It is at such moments that our large current account deficit, our deepening growth sacrifice and uncertain political intentions could serve as multiple red rags to a herd of already enraged bulls.
Something unfunny happened only last week in Turkey, a country with a 7% of GDP current account deficit, inflation gone double digits, rising interest rates imposing potential growth sacrifice and a troubled political condition.
Even if Turkey were not to get clobbered shortly in isolation, it is a closely watched compatriot of South Africa with a similar profile (fatally in the same time zone) and it has just weakened its defences and reduced its attractiveness to global investors.
A market response, demanding higher risk premiums, could potentially spill over to
But even if
Enormous trade deficits mark the region, with rapid credit expansions, overworked asset (housing) markets, greatly increased household indebtedness, double-digit inflation and apparently not a care in the world as the fun continues.
Iceland was at the time a largely isolated case of financial market unease, with no clear contagion developing towards the emerging market class.
We are rather exposed in our make-up at the very moment that we are fully absorbing the global oil and food contagion currently disturbing our inflation, interest rates, asset markets and GDP growth.
No wonder our macro policymakers are rather proactive at present.
Now is hardly the time to have to absorb a second massive external disturbance, superimposed on the first. But that risk isn’t negligible. For which reason one should not think in terms of precise point-forecasts for things like the Rand, inflation, interest rates and the rest.
Instead, one should think out of the box in wide ranges covering all potential eventualities, especially downside ones, given global conditions and the risks they pose.
Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on www.fnb.co.za/economics
FERRIER INTERNATIONAL keeping you informed. Register with us today.