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Cape Town - The chief cause of the rand’s depreciation over the past week was anxiety over the upcoming Fed rate hike, said Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
It noted, the rand lost ground against major currencies last week, falling against the US dollar from R/$13.08 to 13.18 and against the euro from R/€13.81 to 14.05.
South Africa economic review
• GDP unexpectedly contracted in the fourth quarter (Q4) by 0.3% quarter-on-quarter annualised in contrast to the 0.6% consensus growth forecast. Although Q3 growth was revised upwards from 0.2% to 0.4% GDP grew in 2016 as a whole by just 0.3% year-on-year.
On the production side, the main culprit was agriculture which disappointingly contracted by 0.1% on the quarter despite expectations of improved winter crops. On the expenditure side, fixed investment expenditure grew by 1.7% annualised compared with a 3.5% contraction in Q3, helped by a surge of nearly 20% in government capital expenditure.
However, private sector fixed investment contracted by a further 1.7%. While government consumer spending growth slowed from 1.9% in Q3 to just 0.3%, household consumption spending growth remained surprisingly resilient at 2.2% annualised.
Household spending on durables showed its first positive reading in three years. Notably, there was a significant drawdown in inventories in Q4, subtracting 0.5 percentage points from GDP growth, which bodes well for growth in coming quarters as inventories are replenished.
• Dr. Monfort Mlachila, the IMF’s senior representative in South Africa, highlighted the importance of neighbouring African countries to South Africa’s economic outlook, stating that this fact is sometimes overlooked. The neighbouring region accounts for 30% of South Africa’s total exports and an even greater proportion of manufacturing exports, making it the country’s largest export destination.
The drought that hit a large part of the region in 2015 and 2016 had a substantial impact on economic growth across neighbouring countries, while the oil price slump affected growth in large oil exporting economies, Nigeria and Angola. Improved rainfall will bolster the region’s economic growth via better crop yields and through increased energy supply in countries reliant on hydroelectricity while a rising oil price will bolster the outlook for oil exporting economies.
The week ahead
• Manufacturing production: Due on Tuesday 14th March. According to consensus forecast manufacturing production growth is expected to improve from -2.0% year-on-year in December to 0.4% in January. The manufacturing purchasing managers’ index (PMI) regained the key 50-level at the start of the year helped by rising export and domestic orders, indicating a recovery in actual production numbers.
• Mining production: Due on Tuesday 14th March. Mining production growth is expected to rebound from 1.9% year-on-year contraction in December to positive growth of 3.7% in January, helped by the base effect of weak comparative data, rising demand and firming commodity prices. Having contracted in 2016 as a whole by 4.9% mining production is projected to return to positive growth in 2017.
• Retail sales: Due on Wednesday 15th March. According to consensus forecast retail sales growth is projected to increase from 0.9% year-on-year in December to 1.7% in January, albeit still at depressed levels. Retail sales are constrained by weak consumer confidence and an absence of credit extension.
Although recent tax increases further undermine consumer confidence there will be some relief in the second half of the year from lower inflation and potential interest rate cuts.
• RMB Business Confidence Index: Due Wednesday 15th March. The business confidence index is projected to improve from 38 in the fourth quarter (Q4) 2016 to 42 in Q1, according to consensus forecast.
Although still below the key 50-level, which demarcates expansion from contraction, the gain would be encouraging, reflecting South Africa’s continued investment grade credit rating, a solid state budget, reduction in political uncertaintly, and improving export demand.
Technical analysis
• While the rand has broken below key resistance levels versus the dollar at R/$ 13.20 and 13.00 the strengthening trend is not confirmed by momentum indicators, signalling that the currency is overbought.
• 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 key £/$1.25 level support level has been broken opening up a £/$1.18-1.22 target.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.
• The benchmark R186 SA Gilt yield is firmly below the key support level of 9.0% confirming the mini-bull market in bonds which has been in place since the start of the year.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent crude price is well supported at $50 a barrel and having broken key resistance at $55 is targeting further gains to the next key level at $60. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 500 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• 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 isolation, Fed rate hikes would undermine the valuation of risk assets. However, like most cycles this Fed hiking cycle coincides with an acceleration in global economic growth, firming in commodity prices and increasing demand for emerging market exports. Global GDP growth is expected to accelerate from 2.5% in 2016 to 3.5% in 2017.
Emerging market exports grew in December by 5.1% year-on-year accelerating to 14.4% in January, with the largest gains recorded by commodity exporters.
• In the last Fed tightening cycle between June 2004 and June 2006 emerging market equities increased sharply. Emerging market equities have outperformed developed market equities in three of the past four Fed tightening cycles.
The same trend is likely to be repeated in 2017, with early signs that emerging market company earnings have stabilised and are beginning to accelerate after recording 15-year lows last year (relative to developed markets).
• During the last Fed tightening cycle between June 2004 and June 2006, the rand depreciated by 17% versus the US dollar from R/$6.14 to 7.18.
However, the ten-year bond yield firmed from over 9% to under 8% while the All Share Index more than doubled from 10 109 to 21 238. The Fed tightening cycle is likely to be positive for the JSE.
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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