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Cape Town - The forward rate agreement market is pricing in a 61% probability of a 25 basis point interest rate hike when the SA Reserve Bank meets on Wednesday.
Economic indicators have changed significantly since July when the Sarb Monetary Policy Committee hiked the repo rate by 25 basis points from 5.75% to 6.0%, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
"Since the last Sarb policy meeting in July the rand has declined by a further 7% against the US dollar and 6.3% on a trade weighted basis.
"Currency depreciation was one of the main factors behind the last rate hike but if the currency’s 6.3% decline since July is anything to go by the Sarb may consider that foreign investors are drawn to SA more for its economic growth potential than for its interest rate carry.
"As such a rate hike would deter rather than encourage foreign capital inflows," says OAM.
READ: Why SA rates may stay on hold
South Africa economic review
• The current account deficit narrowed dramatically from -4.7% of GDP in the first quarter (Q1) to -3.1% in Q2 well below the -5.4% average in 2014 and better than the -3.7% consensus forecast. The improvement is attributed to the trade balance which showed its first surplus since Q4 2011 at 0.3% of GDP compared with a deficit of -1.7% of GDP in Q1.
The value of exports increased in Q2 by 6.9% quarter-on-quarter annualized while imports fell by -0.8%.
Exports of platinum group metals and iron ore were robust in spite of weak pricing and exports of chemical products and vehicles also increased strongly. On the other hand imports were pulled lower by the decline in oil prices.
Unfortunately it is unlikely the current account improvement can be maintained in the context of China’s economic slowdown and further declines in prices of key commodity exports. The potential for strike activity in the gold sector would also undermine trade and current account balances.
• The SA Reserve Bank (Sarb) Quarterly Bulletin reveals that consumer spending halved from a growth rate of 2.4% quarter-on-quarter annualised in the first quarter (Q1) to 1.2% in Q2. Durable goods purchases fell sharply as a result of lower spending on personal transport equipment.
Growth in real household disposable income slowed from 2.2% to 1.6% although household debt to disposable income improved from 78.7% to 77.8%. Growth in gross fixed capital formation (GFCF) weakened further from 1.8% in Q1 to just 1.0%. Growth in private sector capital outlays fell dramatically from 1.6% to 0.1%.
On the other hand fixed investment by general government remained buoyant rising from 5.1% to 5.3% driven by infrastructure spending in energy, water, transport and education sectors. The Quarterly Bulletin points to a poor economic outlook dampened by weak consumer and business confidence.
• Retail sales growth slowed from 3.8% year-on-year in June to 3.3% in July although above the 2.4% consensus forecast. Among the retail categories “hardware, paint and glass” increased 6.3% and “textiles, clothing, footwear and leather” gained 3.9%. On a month-on-month basis retail sales increased by just 0.1% hindered by a 12.4% increase in electricity prices at the start of July.
Combined with recent poor new vehicle sales the latest retail data indicate a substantial loss in momentum in consumer spending.
• Standard & Poor’s (S&P) credit rating agency said that SA’s sovereign credit rating is unlikely to be downgraded over the next 12-18 months unless there is an economic or political shock. The reassurance came following S&P’s recent downgrade of Brazil’s credit rating to sub-investment grade amid concerns that SA and other emerging markets were also at risk.
S&P confirmed that SA’s political and fiscal challenges were very different to Brazil’s although cautioned that the country needed to reduce its current account and fiscal deficits. S&P also urged more “visible” implementation of its economic growth policies. S&P and other credit rating agencies will scrutinize the upcoming Medium Term Budget Policy Statement on 21st October for any sign of fiscal laxity.
South Africa political overview
• The National Union of Mineworkers (NUM) representing around 53% of the gold sector’s labour force said it would recommend that its members accept the latest wage offer from gold mining companies. Gold companies are offering to raise guaranteed wages by up to 32% over the next three years for entry level workers.
However, the Association of Mineworkers and Construction Union (Amcu) representing over 30% of gold sector workers said it would not recommend the latest wage offer. The wage offer could be legally extended to Amcu members if the majority of total union members sign-up to the wage deal although this would not necessarily prevent Amcu from instigating a wildcat strike.
• Finance Minister Nhlanhla Nene said that the Department of Energy’s proposed nuclear procurement programme would be fully transparent and incorporated into the nation’s budgeting process. This is in apparent contradiction to the Department of Energy’s reluctance so far to provide any feasibility analysis or costing projections.
The Medium Term Budget Policy Statement due on 21 October is likely to provide the first insight into the costs of the proposed nuclear procurement programme.
The week ahead
• Consumer price inflation (CPI) due on Wednesday, 23 September. According to consensus forecast CPI is expected to slow from 5.0% year-on-year in July to 4.7% in August as a result of the -3.8% decline in petrol prices during the month.
• Producer price inflation (PPI) due on Wednesday, 23 September. According to consensus forecast PPI is expected to increase from 3.3% in July to 3.6% in August partly reversing the unexpectedly sharp decline in July when it fell from 3.7%.
• SA Reserve Bank (Sarb) Monetary Policy Committee (MPC) meeting, aslo due on Wednesday, 23 September. According to consensus forecast and the forward rate market the Sarb is expected to keep the repo interest rate unchanged at 6.0% amid a weakening economy and falling oil prices, a decision helped by the postponement of the Fed’s anticipated rate hike.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is no sign yet of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.
• 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.
• Despite the recent uptick in bond yields 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 above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield is testing support at 8.70% which if broken could open a new target of 9.5%.
• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction so far is too small for a bull market of the magnitude and duration of the 2009-2015 bull market. The downside target for the MSCI World Equity index is 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 can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.
• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2 070 level confirms a reversal of the upward trend. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.
• Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5 300 support level suggesting further downside ahead.
• Despite recent advances gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.
• The All-Share index has broken below its bull market support level which has been intact since 2009. The downside target for the All-Share index is 41 000.
Bottom line
• Due to the base effect of low year-ago comparative figures consumer price inflation (CPI) is expected to breach the upper-end of the Sarb’s 3% - 6% range during the first half of next year but then return back to within the range in the second half of 2016. The Sarb is likely to see past the temporary inflation breach given that most indicators are signalling a continued slowdown in economic activity.
• Apart from the weaker rand and the expected temporary spike in CPI other factors would suggest a pause in the Sarb’s rate tightening cycle. Since the last MPC meeting the economy recorded a GDP contraction of -1.3% quarter-on-quarter annualised in the second quarter. Forward-looking indicators such as purchasing managers’ indices signal continued loss in economic momentum over the second half of the year.
• Household consumption, which in recent years has compensated for weak mining and manufacturing output, is also running out of steam. In July retail sales grew by just 0.1% on the month and household credit extension slowed to just 3.6% on the year, followed in August by a year-on-year contraction in new vehicle sales of -8.2%. The outlook for the consumer is bleak according to the FNB/ BER consumer confidence index which in the second quarter fell to the lowest since 2001.
• Global factors play a large part in interest rate policy. Global economic growth is slowing led by a marked deceleration in activity in China and other key emerging market economies. The threat of a global slowdown was sufficient to sway the US Federal Reserve into postponing its much anticipated interest rate increase on 17 September. The Sarb is expected to follow suit and keep rates on hold at its policy meeting on 23 September.
• The combination of GDP contraction, decelerating household credit extension and declining consumer confidence should outweigh the Sarb’s anxiety over a potential short-term inflation spike when it makes its rate decision on Wednesday. The Sarb is expected to look past the inflation spike which in any event can be attributed to the base effect of low year-ago figures rather than a sustainable uptrend.
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* 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.
