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Cape Town - Power struggles within government are likely to increase, promising further rand volatility in the months ahead, according to Overberg Asset Management (OAM) in its weekly overview of the economic and political landscape in South Africa.
The rand tumbled in the past week against the US dollar, euro and pound from R/$13.45 to 14.32, from R/€15.20 to 16.17, and from R/£17.57 to 18.79.
News that the Hawks summoned Finance Minister Pravin Gordhan to appear before them to receive a warning statement undermined all the positive sentiment towards the rand created by the smooth local elections.
The attack from the Hawks is being viewed by financial markets as politically motivated raising questions over governance in the country.
South Africa economic review
• Producer price inflation (PPI) accelerated from 6.8% year-on-year in June to 7.4% in July well above the 6.9% consensus forecast. The high PPI reading is attributed mainly to food price inflation which increased 1.5% on the month pushing the year-on-year rate up from an already elevated 11.2% to 12.6%. The biggest culprits were grain mill products which increased 23.7% on the year and sugar and other food products up 33.8%, both drought induced. Although higher meat price inflation is expected in the months ahead due to the fading effect of drought related culling, crop-related prices should subside as harvests normalise.
• Consumer price inflation (CPI) slowed more than expected from 6.3% year-on-year in June to 6.0% in July below the 6.1% consensus forecast. Core CPI excluding food and energy increased slightly from 5.6% to 5.7% with evidence of pass-through inflation from a weaker rand, especially in appliance prices. The gain in core CPI is also attributed to a substantial increase in administered prices, with water and electricity tariffs rising 10.1% and 7.4% on the year. With CPI falling back to the SA Reserve Bank’s 3-6% target range interest rates are likely to remain on hold when the Monetary Policy Committee (MPC) meets on the 22nd September. The longer-term trajectory for CPI and interest rate policy will depend largely on the direction of the rand, which following the currency’s volatility over the past week, is hard to predict making it likely the Sarb will err on the side of caution and hike rates in November.
• The SA Reserve Bank’s composite leading indicator increased for the first time in three months from 90.8 in June to 91.6 in July marking the biggest gain in almost two years. The leading indicator fell year-on-year by -3.0% although by less than the previous month’s decline of -4.4%. Among the nine components making-up the leading indicator, the largest positive contribution came from building plans passed, followed by an acceleration in leading business cycle indicators of SA’s major trading partners. An increase in the number of job advertisements and number of new passenger vehicles sold also contributed. The largest detractors were a narrower interest rate spread (between short and long-term rates) and a decline in number of hours worked in the manufacturing sector.
The week ahead
• Private sector credit extension (PSCE): Due Tuesday 30th August. Growth in PSCE is expected to slow from 7.30% year-on-year in June to 7.0% in July according to consensus forecast, attributed to falling household credit demand. Household credit demand has been affected by high consumer indebtedness, tight credit conditions and rising interest rates.
• Trade balance: Due Wednesday 31st August. According to consensus forecast the trade balance is expected to remain positive in July at R8.1bn although slightly below June’s substantial surplus of R12.5bn. Exports are benefiting from the weaker rand while weak domestic demand is holding back imports.
• Barclays manufacturing purchasing managers’ index (PMI): Due Thursday 1st September. After declining from an elevated 53.7 in June to 52.5 in July the PMI is expected to dip again to 50.9 in August according to consensus forecast. The reading would still be above the key 50-level which demarcates expansion from contraction.
• Vehicle sales: Due Thursday 1st September. The base effect of year-ago comparative data is expected to moderate the decline in new vehicle sales, from -17.0% year-on-year in July to -13.6% in August according to consensus forecast.
Technical analysis
• The rand’s downward break past R/$14.20 opens a new target of 15.10 which is the support line of the appreciating trend that has been in place since January. A break of the R/$15.20 level would open-up a target of 17.00 marking the January low.
• 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 trend-line 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 this year’s 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 $1400 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 50 900 in turn opening a downside target of 45 000. A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE.
The bottom line
• In her speech at the Jackson Hole symposium Fed chair Janet Yellen stated that the case for an interest rate hike had strengthened. Fed vice chair Stanley Fischer said in his speech that there was room for two rate hikes by year-end. According to Fed fund futures the probability of a Fed rate hike in September has increased to 43%. The probability will rise dramatically if the July non-farm payroll numbers released on Friday match the pattern of the past two months and are stronger than expected.
• A Fed rate hike would enhance expectations for a succession of additional hikes, leading to a strengthening in the US dollar. The US dollar index moved sharply higher between May 2014 and February 2015 from 80.0 to 97.50 after the Fed brought its quantitative easing programme to an end but has moved sideways since then. The dollar is poised to resume its uptrend.
• As the world’s reserve currency a stronger dollar would have substantial repercussions for world trade and financial markets. The recent upturn in financial asset pricing would likely reverse amid expectations of successive fed rate hikes. Higher US interest rates would prompt borrowers of US dollars around the world to repay debt, leading to a decline in dollar global liquidity. There is a close correlation between global dollar liquidity and financial risk appetite.
• The US equity market would be an early casualty. Companies making-up the S&P 500 index generate 44% of their revenue outside the US. A stronger dollar would diminish the value of global sales in dollar terms in turn inhibiting US earnings growth. With US earnings already under pressure from rising wage costs and declining profit margins a strengthening dollar may provide the catalyst for a US equity sell-off.
• Commodities are priced in dollars. A stronger dollar will typically cause commodity prices to decline. Lower commodity prices will dent the export revenues, trade balances and GDP growth prospects of commodity exporting economies such as Australia, Brazil and South Africa.
• Emerging market currencies and equity markets would fall victim to a resurgent dollar. Inflows into emerging market bonds and equities could come to an abrupt end. The mere suggestion of a Fed rate hike has caused net inflows into dedicated emerging market equity funds to flatten in the past week while inflows into dedicated bond funds fell to their lowest since July.
• Who will benefit from a stronger dollar? The key beneficiaries will be those economies purposefully seeking a weakening in their domestic currency. Japan and the Eurozone are the most noteworthy examples. A weakening of the yen and euro versus the dollar would provide economic stimulus via an improvement in terms of trade, and especially in Japan’s case an increase in imported inflationary pressure. Just as a strong dollar would impact US earnings, a weak yen and weak euro would boost Japanese and Eurozone earnings in turn fueling equity market rallies in those regions.
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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