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Rand rides recovery in global risk appetite

Feb 23 2016 19:46

Cape Town - The rise in US equity markets is symptomatic of a broad-based recovery in global risk appetite, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

"All global financial markets are benefiting, including emerging market currencies. The rand has gained over the past week by a substantial 4% against the US dollar," according to OAM.

The JSE All Share index has increased by only 1% although this is due mainly to the large rand-hedge component of the index.

According to OAM positive developments in three main perceived threats to global market stability have led to a significant improvement in global and local risk appetite.

These include the collapsing oil price, Fed interest rate hikes, and the devaluation of the yuan.

"With the moderation in risk form the oil market, Fed policy and China’s currency devaluation, there is likely to be lift in global financial markets over the short-term, especially beneficial to emerging market currencies," says OAM.

"The rand should benefit over the short-term."

South Africa economic review

• On Wednesday Finance Minister Pravin Gordhan will deliver his first Budget speech since being re-appointed last December. The Budget is especially important due to the need for government to re-establish its credibility following 9/12 when former finance minister Nhlanhla Nene was unceremoniously dismissed.

Furthermore, the outcome of the Budget will largely determine whether the credit rating agencies cut SA’s debt rating to “junk” status. Fortunately Gordhan has significant political support for what will inevitably be a difficult job, balancing a probable 1% increase in the VAT rate and partial privatisation of state-owned enterprises (SOEs) with traditional populist ANC rhetoric.

The support for the new finance minister has come at the expense of President Zuma who begrudgingly announced at the state of the nation address debate that “stronger measures to restore a sustainable fiscal path have been endorsed at the highest levels of government.”

The speech is likely to include decisive statements on cutting state wastage and potentially a freeze on new employment in the public sector. The speech is also likely to mirror the recently released presidential report on SOE’s which recommends partial privatisation.

• Moody’s credit rating agencies issued its second warning on SA’s outlook in a month. The rating agency warned that the current drought could tip the economy into recession and more aggressive monetary policy could weigh further on the growth outlook. Moody’s forecasts SA GDP will grow by just 0.5% in 2016 and 1.5% in 2017.

Moody’s has SA on a credit rating two notches above “junk” status so the country would still maintain its investment grade status in the event of a downgrade. However, Standard & Poor’s (S&P), which rates SA just one notch above junk, also cited the danger of a sudden and sizeable increase in interest rates, which could pose a threat to bank asset quality.

• The latest quarterly survey by the Manufacturing Circle indicates manufacturers remain pessimistic in their outlook with many saying they would cut jobs. Over 60% of respondents confirmed they expected conditions to deteriorate over the next 12 months despite the improvement in terms of trade from a weaker exchange rate. The survey findings resonate with a recent IMF paper which cited electricity outages, limited competition and restrictive labour markets as key factors inhibiting companies from exploiting the weaker currency.

• Retail sales fell in December by -0.9% month-on-month in sharp contrast to the +2.45 growth in November and worse than the -0.7% consensus forecast. However, due to the base effect of weak year-ago comparative data retail sales grew +4.1% on the year up from +3.8% in November.

On a quarter-on-quarter basis retail sales increased in the fourth quarter (Q4) by +5.2% annualised the fastest pace since Q2 2013. The retail sales figures should provide solid support to Q4 GDP growth. However, the tailwind of lower fuel prices is likely to be mitigated during 2016 by rising inflation and interest rates and expected tax increases which will almost certainly dampen the rate of retail sales growth this year.

• Consumer price inflation (CPI) jumped sharply higher from 5.2% year-on-year in December to 6.2% in January above the SA Reserve Bank’s 3-6% target range and above the 6.0% consensus forecast. The increase is largely attributed to the base effect of comparative year-ago fuel prices with fuel price inflation rising from -1.2% on the year in December to 10.0% in January.

Food price inflation also increased sharply with vegetable price inflation rising from 9.4% to 14.1% and meat inflation rising from 4.1% to 4.3% putting an end to the deflationary impact of drought-induced livestock culling. Surprisingly core CPI, which excludes volatile food and energy costs, also accelerated from 5.2% to 5.6% well above the 5.3% consensus forecast.

Encouragingly however, there was little evidence of any spillover from the weaker rand with most currency sensitive categories showing little inflationary increase. Most of the core CPI uptick is attributed to service prices which are less prone to the currency effect.

• Foreign investors bought a net +R0.8bn worth of domestic bonds in the past week taking net purchases for the month-to-date and year-to-date to +R0.7bn and +R0.6bn respectively. However, foreign investors remained net sellers of domestic equities, selling a further –R2.1bn in the past week. Foreigners have sold a net -R11bn worth of SA equities since the start of the month and -R21bn since the start of the year.

The week ahead

• Budget Speech: Due Wednesday 24th February. Finance Minister Pravin Gordhan will deliver his first Budget speech since being re-appointed last December. The Budget is especially important. The government needs to re-establish its credibility following the shock dismissal of former finance minister Nhlanhla Nene.

Furthermore, the outcome of the Budget will largely determine whether the credit rating agencies cut SA’s debt rating to “junk” status.

• Unemployment rate: Due Thursday 25th February. According to consensus forecast the unemployment rate is expected to show a slight increase from 25.5% in the third quarter (Q3) last year to 25.6% in Q4. Loss in economic momentum should be mitigated by growth in temporary employment ahead of the festive season.

• Producer price inflation (PPI): Due Thursday 25th February. According to consensus forecast PPI is expected to spike higher from 4.8% year-on-year in December to 6.3% in January due to the base effect of weak year-ago comparative data and sharp increases in food costs.

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 little sign so far 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 broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.

• The MSCI World Equity index has broken downward from a rising wedge formation 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 around June 2016.

• The S&P 500 index has broken downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. 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 $30 support level suggests a continuation of the weakening long-term trend to a downside target of $25. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $4 500 support level suggesting further downside ahead.  

• Gold has broken its recent downtrend by rising decisively above the $1 100 resistance level. An extended break above $1 250 is needed to confirm the end of gold’s bear market.

• The JSE All Share index remains below the 24-month moving average at 50 600. The recent consolidation pattern between 47 000 and 49 000 is likely to be resolved with a break to the downside to an initial target of 45 000 and an ultimate target of 43 000.

Bottom line

• Last week the S&P 500 index enjoyed its best weekly gain since November. The rise in US equity markets is symptomatic of a broad-based recovery in global risk appetite. All global financial markets are benefiting, including emerging market currencies. The rand has gained over the past week by a substantial 4% against the US dollar. The JSE All Share index has increased by only 1% although this is due mainly to the large rand-hedge component of the index.

• What is causing the significant improvement in global and local risk appetite? Since the start of the year the three main perceived threats to global markets stability have been the collapsing oil price, Federal Reserve (Fed) interest rate hikes, and the devaluation of the yuan. Over the past week there have been positive developments in all three areas, providing the catalyst for a re-rating in financial asset prices.

• Russia, Saudi Arabia, Qatar and Venezuela have agreed to freeze oil output at current levels. The rest of Opec, with the exception of Iran, is likely to join the agreement. The production freeze is positive for oil producers increasing the likelihood that the oil market will find a new equilibrium before year-end leading to a recovery in the Brent oil price to the $40-50 range.

A sustainably higher oil price will reduce the probability of a high profile credit default among oil players or one of their creditors. A higher oil price will also reduce the forced selling by Middle East sovereign wealth funds of their global financial assets.

• Minutes from the Fed’s latest policy meeting indicate that the US central bank is concerned about the risks of slowing global economic growth and global financial market volatility. Interest rate swap markets corroborate the increasingly “dovish” approach. From predicting 100 basis point aggregate interest rate hikes during 2016 as recently as two months ago the swaps market is now pricing in only 35 basis points over the next 24 months. Markets are even ascribing a 15% probability that the Fed will adopt negative interest rates.

• Zhou Xiaochuan the Governor of the Peoples’ Bank of China (PBOC) has sought to alleviate concerns over yuan devaluation. The PBOC Governor reiterated the leadership’s pledge to not engage in competitive devaluation. He pointed out that the yuan’s recent devaluation was an adjustment to the dollar’s strong gains against other major currencies. He confirmed that the yuan’s fundamentals are supported by strong foreign exchange reserves, healthy external balances, and growing export competitiveness.

• With the moderation in risk form the oil market, Fed policy and China’s currency devaluation, there is likely to be lift in global financial markets over the short-term, especially beneficial to emerging market currencies. The rand should benefit over the short-term.

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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