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Rate hike could hurt already frail economy

Cape Town - Highly indebted households can ill afford an interest rate hike and a move in this direction will dampen an already fragile economy, cautioned Overberg Asset Management in its weekly overview of the South African economic landscape.

OAM said based on increasingly “hawkish” comments from the SA Reserve Bank and its Governor Lesetja Kganyago, the Monetary Policy Committee (MPC) is widely expected to hike the repo rate when it decides on interest rate policy on Thursday.

According to market consensus the repo rate will be raised by 25 basis points from 5.75% to 6.0%.

"Unfortunately a rate hike will dampen an already fragile economy and it may not necessarily have the desired effect of keeping inflation in check," said OAM, adding that households in SA are already highly indebted with little capacity to borrow more.

South Africa economic review

• Growth in retail sales decreased from 3.4% year-on-year in April to 2.4% in May below the 2.7% consensus forecast. The “hardware, paint and glass” category increased a robust 9.0% contributing 0.6 percentage points to the headline figure. The “general dealers” category which increased 2.3% on the month contributed the bulk with 0.9 percentage points. On a month-on-month basis retail sales increased just 0.1% and on a three-month-three-month basis by 0.8% illustrating the declining trend in growth. Consumer confidence has deteriorated in the past two months due to the rebound in petrol prices and increase in consumer price inflation.

• Foreign investors were net buyers of R6.2bn worth of bonds and R0.5bn worth of equities last week. Foreigners accounted for only 34.3% of total equity market traded volume which is low compared to the year-to-date average of 39.4%. Foreign equity buying was concentrated in the financial sector, followed by the industrial sector and resource sector, while net selling was noted in the property sector. For the year-to-date foreign net buying of bonds and equities amounts to R12.78bn and R35.93bn respectively.

• In its report on SA the OECD recommended labour market reforms, a reduction in regulation in order to promote competition, and a pick-up in targeted infrastructure expenditure. These themes echo the concerns of other external institutions including credit rating agencies and the IMF.

The OECD also recommended a change to SA’s tax regime, in particular increased taxes on high net worth individuals and high income earners.

READ: SA must raise tax on rich to lift revenue - OECD

While emphasizing greater taxation of the wealthy, the report recommended that lower incomes should also be taxed, that VAT should be raised and zero rated items should be eliminated in favour of more accurate poverty alleviation. The report notes that SA’s tax revenues are less than 30% of GDP compared with an emerging market average of 35%.

Political review

• The threat of strike action in the gold sector was given a temporary reprieve after the Association of Mineworkers and Construction Union (Amcu) announced that it would return to another round of wage talks. Amcu is demanding a 120% increase in the basic wage to R12 500 per month.

The gold mining industry has said the tabled increase would lift aggregate wage costs from R23.5bn to R40bn, an increase of 70%. Although the latest development is positive the precedent of last year’s platinum sector wage talks does not bode well for the domestic gold industry.

Meanwhile this week’s sharp fall in the gold price towards a multi-year low of $1100 per ounce offers little respite.

The week ahead

• Consumer price inflation (CPI) due on Wednesday, 22 July. CPI has risen steadily over the past three months from 4.2% in March, to 4.6% in April and 4.8% in May. Further acceleration in CPI is expected in June to 5.1% due to the inflationary effect of the weaker rand, drought-induced increases in the maize price and fuel price increases. This will be a key data point coming a day before the SA Reserve Bank’s monetary policy decision.

READ: Expect rate hike, warns expert

• SA Reserve Bank MPC meeting due on Thursday, 23 July. According to consensus view the Sarb will raise the repo rate by 25 basis points from 5.75% to 6.0% to address rising inflationary pressures and to pre-empt the Federal Reserve’s expected rate hike in September. The Sarb will be concerned that the rand may come under further pressure unless the interest rate differential between US and SA interest rates is held constant.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break above the key “Fibonacci” level of R12.45/$ signals further depreciation in the rand to the R13.00/$-level.

• 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 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.

• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.  

• 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- to 17-year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 is breaking down from a rising wedge pattern, which is traditionally a trend-changing pattern. A break below the previous low of 2 067 will confirm a trend reversal. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, has already broken down from its rising wedge.

• Brent crude’s break below the key $60 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 2011 low of $6 500 suggesting a further downside move to $5 500. 

• Despite recent advances gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 400, $1 300 and $1 250. Gold’s next target is $1 100 and is likely to breach $1 000 before the bear market ends.  

• The All-share index has lost most of its gains since the start of the year. The index is testing the key support line which has been in place since 2009. A break below 50 000 would signal a sharp move lower to the October low of 47 000.

Bottom line

• Economic data shows slowing household credit extension and retail sales growth. There is little sign of “demand pull” inflation either at household level or in terms of investment demand, which is also weak. Although consumer price inflation (CPI) has risen steadily over the past three months from 4.2% in March to 4.8% in May and expected to come in at 5.1% in June, the inflation rate is being driven primarily by “supply side” pressures.

• CPI has accelerated due to the weaker rand, higher drought-induced maize prices, and higher state administered prices including municipal rates and taxes, Eskom tariffs and fuel levies. CPI has accelerated due to supply-side inflationary pressures which an interest rate hike would not influence.  

• The only desirable effect of a rate hike would be to limit the rand’s rate of depreciation by narrowing the interest rate differential between SA and the US. Expectations are rising that the US Federal Reserve will soon embark on its cycle of monetary policy normalisation with the first Fed rate hike likely in either September or December. The Sarb is keen to keep ahead of the Fed. However, the Fed’s timing is by no means certain and if the Sarb hikes too soon the rate hike will be long forgotten by the time the Fed hikes rates. The pain would have been for nothing and the Sarb would have to repeat the process off a higher base.

• In any event inflationary pressures are showing signs of easing since the Sarb’s last policy meeting in May. The Brent oil price has declined from a peak of close to $70 per barrel in May to less than $57 and is poised to go lower with supply growth far exceeding demand growth. In addition energy regulator Nersa rejected Eskom’s application for an aggregate 25% increase in electricity tariffs in the current financial year.

• CPI was unusually low in early 2015 coinciding with a significant fall in oil prices, which will contribute to >6% CPI in early 2016. CPI is expected to exceed the Sarb’s 3-6% target range in the first quarter of 2016 but should return to target by the third quarter as the base effect of low comparative measures works through the system.

• The arguments for implementing a rate hike are far outnumbered by the arguments for postponing a tightening in policy. Given the embattled state of household finances and the almost recessionary state of the economy the Sarb will hopefully keep rates on hold.  

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.


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