Rand’s depreciation set to continue

Cape Town - Pressure on the rand is likely to resume amid continued policy uncertainty, political tensions, and lacklustre economic growth, according to Overberg Asset Management (OAM) in its weekly overview of the economic and political landscape in South Africa.

South Africa economic review

• As expected Standard & Poor’s Global Ratings (S&P) granted SA a reprieve, leaving its foreign-currency sovereign credit rating unchanged at BBB-. S&P credited SA’s prudent fiscal consolidation plans and Eskom’s much improved electricity supply. The National Treasury announced that: “The benefit of this decision is that SA is given more time to demonstrate further concrete implementation of reforms that are underway aimed at achieving higher levels of inclusive growth and place public finances on a sustainable path.” While a downgrade to sub-investment grade has been avoided over the near-term, the threat has not disappeared. S&P has kept SA on “negative watch” for a potential downgrade at the next bi-annual review in December. S&P would probably have downgraded SA last Friday if the decision to push a country into sub-investment grade was not so momentous. S&P may be less lenient next time.

• There were substantial net foreign portfolio inflows into SA’s bond and equity markets in the past week of R6.3bn and R23.3bn, respectively, following Standard & Poor’s Global Ratings’ (S&P) decision to maintain SA’s investment grade rating. The rand strengthened over the past week from R/$15.68 to 15.08, from R/€17.43 to 17.15, and from R/£22.88 to 21.68, respective gains versus the dollar, euro and pound of 3.8%, 1.6% and 5.2%. However, gains against other emerging markets were less impressive suggesting the rand’s appreciation may have been influenced less by S&P’s reprieve than the US non-farm payroll numbers. The US data was extremely weak pushing back the expected date for the next interest rate hike, which will benefit emerging market currencies. The rand appreciated against the Brazilian real, Indian rupee, Indonesian rupiah, Mexican peso and Philippine peso by 0.3%, 0.5%, 0.5%, 0.1% and 0.5% respectively.

• Total domestic vehicle sales fell in May by -10.4% year-on-year worse than the -9.2% contraction in April and far worse than the -7.7% consensus forecast. Domestic vehicle sales have fallen on a year-on-year basis for 15 straight months reflecting weakening consumer demand. Domestic passenger vehicle sales fell -13.0% on the year a slight moderation from April’s -13.6% decline. Although vehicle export sales growth slowed from 39.1% year-on-year to 0.8% this is due to the base effect of an unusually strong reading in April 2015. On a month-on-month basis vehicle exports increased a robust 2.6%.

• The Barclays manufacturing purchasing managers’ index (PMI) fell from 54.9 in April to 51.9 in May but still above the 50.5 March reading. The PMI has been above the expansionary 50-level for three straight months indicating a stabilization in manufacturing conditions. Most sub-indices remained above the key 50-level, although the employment index disappointingly declined from 50.4 to 48.0. The business activity index fell from 56.4 to 52.9, but still a respectable level. Encouragingly, the expected business conditions index, which measures prospects in six months’ time, moderated only slightly from 55.9 to 54.1, indicating a sustainable improvement in manufacturing output. Unfortunately, the prices index increased further from 77.7 to 80.1 confirming growing inflationary pressure and the likelihood of further interest rate hikes.

• SA Auditor General Kimi Makwetu announced in his 2014/15 local government audit that the number of municipalities receiving a clean audit had increased from 40 to 54. Although a fraction of the total 272 municipalities this is a substantial improvement from 13 just five years ago. However, irregular expenditure has more than doubled over the past five years to almost R15bn and unauthorised expenditure has increased threefold to over R15bn. The Auditor General noted that 92% of municipalities had financial difficulties.

• SA unexpectedly registered a second consecutive trade surplus in April. Although SA’s trade surplus decreased from R2.0bn in March to R0.4bn in April this was better than the -R0.9bn consensus forecast deficit and the –R2.5bn deficit recorded in April last year. The cumulative trade deficit for 2016 to date is –R16.8bn the lowest in the first four months of the year since 2012 and 41% less than last year’s deficit. The improving trade data indicates that the weaker rand is finally benefiting the economy via export competitiveness and reduced imports.

The week ahead

• GDP growth: Due Wednesday 8th June. According to consensus forecast quarter-on-quarter annualised GDP growth is expected to deteriorate from 0.6% in the fourth quarter (Q4) last year to -0.1% in Q1. With the agriculture and mining sectors already in recession many economists expect a negative GDP reading.
 
• Fitch credit rating announcement: Expected Wednesday 8th June. Fitch has not disclosed the date of its announcement but according to consensus it is expected to be Wednesday. Fitch’s current BBB- foreign currency sovereign debt rating is expected to be maintained although it is likely the outlook will move from “stable” to “negative”.

• Mining production: Due Thursday 9th June. According to consensus forecast the year-on-year decline in mining production is expected to moderate from -18.0% in March to -7.20% in April with the base effect of weak year-ago production levels coming to the rescue.

• Manufacturing production: Due Thursday 9th June. The strong improvement in the Barclays’ manufacturing purchasing managers’ index in April indicates manufacturing production will rebound from its -2.0% year-on-year contraction in March to growth of +0.40% in April, according to consensus forecast.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation.

• 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 1.8% and 2.0%. 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 trendline 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 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.

• Despite the recent 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 broken its recent downtrend by rising decisively above the $1 100 resistance level. An extended break above $1250 is needed to confirm the end of gold’s bear market.

• 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 50,700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.

The bottom line

• As expected Standard & Poor’s Global Ratings (S&P) granted SA a reprieve, leaving its foreign-currency sovereign credit rating unchanged at BBB-. The rand strengthened by about 3% versus the dollar, pound and euro after the rating decision was announced on Friday evening and a further 1% on Monday.

• S&P credited SA’s prudent fiscal consolidation plans and Eskom’s much improved electricity supply. The National Treasury announced that: “The benefit of this decision is that SA is given more time to demonstrate further concrete implementation of reforms that are underway aimed at achieving higher levels of inclusive growth and place public finances on a sustainable path.”

• While a downgrade to sub-investment grade has been avoided over the near-term, the threat has not disappeared. S&P has kept SA on “negative watch” for a potential downgrade at the next bi-annual review in December. S&P would probably have downgraded SA last Friday if the decision to push a country into sub-investment grade was not so momentous. S&P may be less lenient next time.

• S&P still needs convincing that the economy will recover and that the Treasury will be able to implement its budget reduction targets. S&P said it “could lower the ratings this year or next if policy measures do not turn the economy around.” S&P is looking for bold policy measures including labour reforms, mining sector reforms, and reforms of state-owned enterprises.

• S&P was explicit in voicing its concerns over political uncertainty: “Rising political tensions are accentuating vulnerabilities in the country’s sovereign credit profiles.” S&P went on: “Political tensions have increased in SA since the removal of former Finance Minister Nhlanhla Nene; the Constitutional Court ruling against President Jacob Zuma; and periodic disputes between key government institutions and within the ruling ANC. We believe that these political factors, if they continue to fester, could weigh more on investor confidence than inconclusive labour or mining sector reform.”

• S&P’s assessment suggests that for the country to avoid losing its investment-grade rating in December, much will depend on unimpeded policy implementation by “market-friendly” factions within government. Much will also depend on the outcome and the ANC’s response to the local elections on 3rd August.

• The rand’s short-term boost from S&P’s positive credit rating decision provides investors with an excellent opportunity to diversify out of SA-based assets. Pressure on the rand is likely to resume amid continued policy uncertainty, political tensions, and lackluster economic growth.

• Besides the rating decision the rand has gained some reprieve, alongside other emerging market currencies, from weak US employment data which pushed back the likelihood of a June US rate hike. Even though a US rate hike may have been delayed the Fed is keen to normalise interest rates. One or two rate hikes before year-end are inevitable, which will place emerging market currencies, including the rand, under renewed pressure.

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* 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.

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