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Cape Town - The latest slump in the rand is attributed to much stronger than expected US unemployment data, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
According to OAM this signals the growing likelihood of a US interest rate increase before year-end.
"A strengthening dollar will drain dollar-based liquidity from global financial markets. Emerging economies dependent on foreign capital inflows will be particularly susceptible," says OAM.
The rand will be one of the most conspicuous casualties of dollar strength, especially susceptible due to SA’s high current account deficit, growing budget deficit strains, and rising external indebtedness, according to OAM.
South Africa economic review
• Speaking at a conference last Friday SA Reserve Bank (Sarb) Deputy Governor Francois Groepe reiterated that the central bank’s core mandate is price stability and that it stands ready to act to stem any increase in inflationary expectations.
He cautioned that consumer price inflation is expected to breach the upper end of the Sarb’s 3-6% target range over two quarters in 2016, which may drive inflationary expectations upwards. His remarks signal the Sarb’s commitment to additional interest rate increases in spite of the marked slowdown in economic growth.
Following buoyant US payroll data and the growing likelihood of a Fed December rate hike, the Sarb may be tempted to hike the repo rate by a further 50 basis points at its policy meeting on 19th November.
• Growth in the Absa house price index slowed from 5.3% year-on-year in September to 4.8% in October, well below its recent peak of 9.7% in October 2014. On a month-on-month basis the house price index slowed to just 0.2% the slowest since early 2012.
The slowdown is attributed to small- and medium-sized houses with price growth slowing to just 2.9% on the year, while the price growth of larger houses increased from 7.2% the previous month to 7.7%.
The general deceleration in nominal house price growth amid rising inflation and prospects for higher interest rates indicates negative real house price growth in the first half of 2016.
• Speaking at a conference at Wits University Judge Dennis Davis, who is heading the Davis Tax Committee review of SA’s tax system, warned that growing corruption in the country could undermine the integrity of the tax system and lead to a “tax revolt”.
Given the country’s current fiscal strain Judge Davis was critical of growth in the public wage bill and continued financial support for state-owned enterprises in particular SA Airways. He said expenditure should be prioritised towards infrastructure development and student bursaries.
Regarding tax increases he said a one percentage point increase in VAT would raise an additional R15-20bn a year but would affect the poor the most. An increase in the top marginal rate of income tax would be more politically expedient but would only raise an additional R3-5bn.
Judge Davis cautioned against raising corporate income tax as this rate should remain competitive with other countries.
• The Standard Bank Markit purchasing managers’ index (PMI), measuring private sector activity in both manufacturing and service sectors, fell from 47.9 in September to 47.5 in October below the 47.7 consensus forecast and still in sub-50 contractionary territory.
The index has been contractionary for five straight months and is now at its lowest level in fifteen months. The continued decline is in spite of an easing in load shedding, which suggests growing demand constraints.
The forward-looking new orders sub-index fell sharply attributed to currency volatility and market uncertainty. The new export orders index also suffered a large decline in spite of the competitive boost from a sharply weaker rand.
• Foreign investors sold a net –R3.07bn worth of domestic bonds in the past week, putting an end to four straight weeks of net purchases and reducing year-to-date inflows to R25.34bn. Foreign investors remained net sellers of domestic equities with outflows of –R2.1bn in the past week.
Equity sales were concentrated in the property sector while buying was noted in the financial sector. Foreign equity purchases for the year-to-date remain positive at a net R12.84bn although the heavy –R19.69bn net selling over the past month lifts the chances of a market correction in the near-term.
South Africa political overview
• The ANC elective conference in KZN saw the former provincial secretary Sihle Zikalala elected as chairperson of the party in the province. Zikalala is together with the “premier league” of provinces, including Mpumalanga, North West and Free State, likely to endorse Nkosazana Dlamini-Zuma for president at the ANC’s national elective conference in 2017.
At face value Zikalala’s victory has impeded Deputy President Cyril Ramaphosa’s ascendancy to the presidency. However, there are some suggestions that Dlamini-Zuma’s growing support is merely a smokescreen to disguise the inevitability of Ramaphosa’s election, thereby squeezing out other bids for the position.
The week ahead
• Manufacturing production: Manufacturing production increased 0.9% year-on-year for September after contracting by a revised -0.3% in August, Statistics South Africa says. This will weigh on third quarter GDP growth, which is in danger of being negative. The GDP figures will be released on 24th November.
• Mining production: Due Thursday 12th November. According to consensus forecast the 3.80% year-on-year growth in mining production achieved in August is expected to deteriorate to a contraction of -0.90% in September. This will weigh on third quarter GDP growth, which is in danger of being negative. The GDP figures will be released on 24th November.
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%.
• Although recently recovered the MSCI World Equity index broke 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 was 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.
• Although recently recovered the S&P 500 index broke 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 $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 $5 000 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.
• Although recently recovered the All Share index broke below its bull market support level which has been intact since 2009. The downside target for the All Share index is 43 000.
Bottom line
• The rand’s woes continue. The currency depreciated against the US dollar for a third consecutive week taking its losses since the start of the year to -18%. The latest slump in the rand is attributed to much stronger than expected US unemployment data, signalling the growing likelihood of a US interest rate increase before year-end.
US nonfarm payrolls increased during the month of October by 271 000 substantially above the 187 000 consensus forecast. Futures markets immediately raised the probability of a December Fed rate hike from 30% to 75%.
• The Fed has been communicating for a long time the desire to start normalising monetary policy and lift interest rates away from zero. Fed chair Janet Yellen had made it clear last week prior to the unemployment data release that there was a “live possibility” for a rate hike at the policy setting meeting on 15-16 December. Although employment data tends to be volatile the latest payroll figures almost cement the case for a rate hike.
• The prospect of an imminent US rate hike has prompted a swift response in global currency markets. The US dollar has rallied across the board especially against emerging market currencies. The dollar rally is expected to continue ahead of the Fed’s rate decision on 16th December and thereafter as the interest rate gap between the dollar and other currencies widens.
• A strengthening dollar will drain dollar-based liquidity from global financial markets. Emerging economies dependent on foreign capital inflows will be particularly susceptible.
The rand will be one of the most conspicuous casualties of dollar strength, especially susceptible due to SA’s high current account deficit, growing budget deficit strains, and rising external indebtedness.
Renewed rand weakness will pose a growing threat to SA’s bond and equity markets, will lead to imported inflationary pressure and ultimately further rate hikes from the SA Reserve Bank.
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.
