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Cape Town - As the most liquid emerging market currency the rand has benefitted from broad-based investor demand for emerging market assets, strengthening since the start of the year against the US dollar, sterling and euro by +8.40%, +21.63% and +7.15% with respective gains of +2.04%, +16.13% and +5.20% in the past month alone.
Against this background, local investors may be asking if recent rand strength is offering a unique opportunity to increase offshore exposure. The question to be asked is can the rand sustain its current strength, says Overberg Asset Management (OAM) in its weekly overview of the economic and political landscape in South Africa.
"The current account deficit, weak GDP growth environment and uncertainty over government policy, suggest the rand is unlikely to keep up with other emerging market currencies over the medium-term."
South Africa economic review
• The rand continued its gains for a fourth straight week, appreciating over the past week against the US dollar, euro and pound from R14.34/$ to 14.32, from R15.88/€ to 15.72, and from R18.98/£ to 18.74.
The rand also gained versus emerging market currencies, appreciating against the Argentinian peso (+2.5%), the Brazilian real (+1.5%), the Indian rupee (+0.9%), Malaysian ringgit (+3.2%), Indonesian rupiah (+1.9%), Philippian peso (+1.4%), and Singapore dollar (+1.6%).
The ten-year R186 government bond yield increased slightly from 8.73% to 8.74%. Net foreign capital inflows into SA since the start of the year total R50bn, the largest cumulative inflow since 2012.
• As expected the SA Reserve Bank (SARB) kept the benchmark repo rate unchanged at 7.0%. The decision was based on a unanimous vote.
The SARB lowered its forecast for consumer price inflation (CPI) for 2016 from 6.7% to 6.6% and for 2017 from 6.2% to 6.0% and for core CPI, excluding food and energy costs, from 5.9% to 5.8% for 2016 while leaving the 2017 forecast unchanged at 5.7%.
The SARB projects CPI returning to its 3-6% target range only by the second half of 2017, dashing any hopes of an interest rate cut.
SARB Governor Lesetja Kganyago stressed that a rate cut was not seriously considered and hinted that the rate hiking cycle had not yet been completed. While there is unlikely to be a rate hike in September two further 25 basis point hikes in November and January seem probable.
• Consumer price inflation (CPI) picked-up from 6.1% year-on-year in May to 6.3% in June slightly above the 6.2% consensus forecast. The major contributors were food and alcoholic beverages with 1.7 percentage points, and housing and utilities with 1.6 percentage points. On a month-on-month basis CPI increased 0.6% driven higher by a 4.2% increase in the fuel price and 1.2% rise in actual and owners’ equivalent rentals.
Food prices fell -0.1% on the month although increased 11.0% on the year. Food prices are expected to rise further in the second half of the year due to drought effects. Agbiz reported that SA, traditionally an exporter of maize has already imported 370 000 tons this season and still needs to address a shortfall of around 3.6 million tons.
Core CPI, excluding food and energy, increased moderately from 5.5% to 5.6% although within the SA Reserve Bank’s 3-6% target range.
• Fitch credit rating agency downgraded SA’s local-currency denominated debt by one level from BBB to BBB-, one level above non-investment grade. The new rating is in line with Fitch’s foreign-currency rating, which was downgraded last December.
The National Treasury stated that: “Although the action represents an alignment, it also serves as a timely reminder of the risks of a downgrade that lie ahead and the urgency of actions required to reinvigorate the economy.”
Fitch and Standard & Poor’s Global Ratings, which both have SA’s foreign currency credit rating at one level above “junk” status, will be reviewing their ratings in December.
The week ahead
• SA Reserve Bank Leading Business Cycle Indicator: Released on Tuesday, 26 July. The lead indicator, made up of 13 component data series, projects the direction of the economy in six to twelve months.
It has dropped from 90.9 in April to 90.8 in May. Six of the ten component time series that were available for May 2016 decreased, while four increased. The largest negative contributions to the movement of composite
leading indicator in May came from a decrease in the Bureau for Economic Research’s (BER) average number of hours worked in
the manufacturing sector, as well as a deterioration in the BER Business Confidence Index. The largest positive contributions
in May resulted from an acceleration in the 12-month
percentage change in job advertisement space, followed by a widening in the interest rate spread.
• Quarterly Labour Force Survey: Due on Thursday, 28 July. Having shed 355 000 jobs in the first quarter (Q1), lifting the unemployment rate to 26.7%, there is likely to be a slight improvement in job creation in Q2 in line with slightly better conditions in the manufacturing, mining and agriculture sectors.
• Producer Price Inflation (PPI): Due on Thursday, 28 July. According to consensus forecast PPI is expected to increase from 6.5% year-on-year in May to 6.9% in June driven higher by rising food and fuel prices.
• Trade data: Due on Friday, 29 July. Following the much larger than expected R18.7bn trade surplus in May, a further surplus is expected in June although at a reduced R5.6bn while the May figure will likely be revised lower. The weak rand is boosting export competitiveness.
• Private sector credit extension (PSCE): Due Friday, 29 July. Having slowed sharply from 7.1% year-on-year in April to 6.6% in May PSCE growth is expected to recover to 7.0% in June according to consensus forecast.
Technical analysis
• The rand has rallied sharply following the Brexit vote and the ensuing likelihood that the Fed will refrain from hiking interest rates until 2017. The rand has strengthened below key resistance at R14.50/$ opening targets of R14.15/$ and R13.75/$. The rand is now comfortably below the 50-, 100- and 200-day moving averages. A sustained push below all three would indicate a major trend reversal.
• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.
• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £1.30/$ level provides key support, which if broken would open up a Fibonacci projected target of £1.20-1.24/$.
• The long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.
• The US 10-year Treasury yield has broken below key resistance levels of 1.6% confirming that the major bull trend in US bonds is likely to continue as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield has compressed to its lowest level since “Nenegate” last year falling below key resistance at 9.0%. The yield is now testing the bottom of the current consolidation channel at 8.5%, which if broken will target a yield of 8.0%.
• The MSCI World Equity index has broken downward from a rising trendline which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1,400.
• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur between mid-2016 and mid-2017.
• The S&P 500 index has broken to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index.
• Despite the recent price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target.
Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.
The bottom line
• Emerging market currencies have performed well since the start of the year, especially in the past month after the Brexit vote prompted the world’s major central banks to pledge increased monetary easing. The large capital outflows from emerging markets earlier in the year have eased considerably, falling in June to their lowest in a year. Emerging market inflows have surged in search of higher yields. In the week ended 20 July emerging market bond and equity funds recorded their largest inflows in a year.
• As the most liquid emerging market currency the rand has benefitted from broad-based investor demand for emerging market assets. The rand has strengthened since the start of the year against the US dollar, sterling and euro by +8.40%, +21.63% and +7.15% with respective gains of +2.04%, +16.13% and +5.20% in the past month alone.
• Local investors may be asking if recent rand strength is offering a unique opportunity to increase offshore exposure? The current account deficit, weak GDP growth environment and uncertainty over government policy, suggest the rand is unlikely to keep up with other emerging market currencies over the medium-term.
• The current account deficit widened to 5% of GDP in the first quarter, one of the largest deficits among emerging market economies. While the trade deficit has improved in recent months, any benefit to the current account is being undermined by a structural deficit in the income account, which measures the cross-border flow of interest and dividend payments. Although SA’s net international investment position has improved SA’s income payments to foreign investors are worth almost four times the income received.
• SA’s economic growth is negligible. At its policy setting meeting last week the Reserve Bank reduced its 2016 GDP growth forecast to zero. While a recession, technically defined as two straight quarters of GDP contraction, may be averted the lack of economic growth will almost certainly lead to a credit rating downgrade.
Standard & Poor’s Global Ratings has cited SA’s lack of economic growth as its chief concern, paving the way for a credit rating downgrade at its next review in early December.
• With no sign of any change in leadership President Zuma’s scandal-plagued government is likely to continue fuelling policy and regulatory uncertainty. Repeats of “Nenegate” cannot be discounted and given SA’s dependence on portfolio inflows, will likely prompt recurrences of the rand’s dismal performance in December 2015.
• AB InBev’s acquisition of SABMiller has met all the main conditions and so is likely to proceed during the second half of the year. SABMiller shareholders will receive cash paid in rand at £44 per share from AB Inbev. This will entail an inflow of around R130bn.
However, the inflow will have a more muted effect on the rand’s exchange rate than might be expected. As has happened in the past with large foreign acquisitions of local companies AB InBev’s forex purchases will be largely off-market involving close cooperation between the Reserve Bank and the acquirer in order to manage forex market liquidity.
• Despite the rand’s recent strength, the R/$ is likely to return to around R/$16.50-17.00 by the end of 2017, representing a 20% depreciation from current levels. Existing rand levels offer an attractive opportunity to invest offshore, including in other emerging markets.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
